Q2 2023 Citizens Financial Group Inc Earnings Call
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Your conference will begin momentarily. Please continue to hold.
Good morning everyone and welcome to the Citizens Financial Group second quarter 2023 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 Kristin Silberberg, Executive Vice President Invest Relations. Kristin you may
Thank you, Alan. 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 our second quarter results. Brendan Coughlin, Head of Consumer Banking, and Don McCree, Head of Commercial Banking, are also here to provide additional colour.
We will be referencing our second quarter earnings presentation located on our investor relations website. 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 two of the presentation. We also reference non-GAAP financial measures so it's important to review our GAAP results on page three of the presentation and the reconciliations in the appendix. And with that I'll hand over to you, Bruce. Thanks, Kristin and good morning everyone. Thanks for joining our call today.
The turbulent external environment continued in the second quarter, but we continued to navigate well and we delivered solid financial performance.
In particular, we're pleased with the strong results we achieved around capital, liquidity, and funding.
Our Set 1 ratio grew by 30 basis points to 10.3% in the quarter, and we were able to repurchase in excess of $250 million in stock.
We grew spot deposits by 3% or $5.5 billion and our spot loan to deposit ratio improved to 85%.
Our Federal Home Loan Bank borrowings dropped by $7 billion to $5 billion, and contingent liquidity grew by 20% to $79 billion.
For the quarter we posted underlying earnings per share of $1.04 and ROTCE of 13.9%.
NIIA was down 3%, reflecting higher funding costs in line with our expectations.
Non-interest income grew 4%, slightly less than expected, as capital markets saw a few deals push to the third quarter.
Expenses were broadly stable, as expected, and credit costs continue to be manageable.
One of the highlights of the second quarter was the opportunity to secure a significant influx of talent largely from the First Republic platform to meaningfully augment our citizens private bank and wealth management business.
While expense investments will lead revenues in 2023, we project the business to be accretive in 2024 and significantly profitable in the medium term.
In our presentation this morning, we will highlight this initiative in more detail.
We'll also review several other compelling initiatives that we believe will lead to strong medium-term outperformance.
Execution of these initiatives continues to be strong.
We're setting up a non-core runoff portfolio as a centerpiece of intensified balance sheet optimization efforts. We expect around $9 billion of loan runoff, largely in auto, by the end of 2025.
This capacity will be utilized to fund more strategic loan portfolios.
to pay down high-cost debt, and to build cash and securities.
In parallel, the private bank will grow loans over this period by $9 billion, which will be funded by $11 billion of incremental deposits. The net benefit of all of this is a better deployment of capital, along with positive impact on earnings per share, ROTCE, and liquidity.
We've also included more detail on our CRE loan portfolio. Our General Office Reserve is now at 8%. While we continue to see increases in criticized assets and charge-offs in this particular portfolio, we believe losses are manageable and readily absorbed by reserves and our strong capital position. Policy in Robust R
Looking forward, we anticipate that the environment, while stabilizing, will continue to be challenging.
Our net interest margin will decline again in Q3 given higher funding costs.
We expect our terminal beta to reach 49 to 50 percent at year-end.
RPs should continue to grow sequentially, expenses will be well controlled, and credit should be broadly stable.
We will further build our CET1 ratio while continuing to repurchase shares.
Overall, we're holding an okay on current period performance with mid-teens ROTC in 2023 while making the investments to deliver a stronger franchise, attractive growth and returns and a fortified balance sheet over the medium term.
We continue to build a great bank and we remain very excited about our future. Our capital strength and our attractive franchise position us to attract terrific talent and to take advantage of opportunities as they arise.
With that, let me turn it over to John to take you through more of the financial details. John ? Thanks, Bruce, and good morning, everyone. Let me start with the headlines for the second quarter, referencing slide 5.
For the second quarter, we generated underlying net income of $531 million, an EPS of $1.04.
Our underlying ROTC for the quarter was 13.9%.
Net interest income was down 3% linked quarter and our margin was 3.17%, down 13 basis points with funding costs outpacing the increase in asset yields.
We delivered very strong deposit growth in the quarter reflecting the strength of the franchise with spot deposits of 3% or 5.5 billion.
Period N loans and average loans were down 2% quarter over quarter reflecting the impact of our balance sheet optimization effort.
Period end loans and average loans were down 2% quarter over quarter, reflecting the impact of our balance sheet optimization efforts, including our ongoing runoff of auto.
These dynamics improved our period and LDR to 85% and our liquidity position remains very strong.
We reduced flip borrowings by about $7 billion to approximately $5 billion outstanding at quarter end and we increased our available liquidity by 19% to about $79 billion.
Our credit max and overall position remain solid.
Total NCOs of 40 basis points are up 6 basis points linked quarter as expected, primarily reflecting higher charge-offs in Cree General Office.
We recorded a provision for credit losses of $176 million and a reserve bill of $24 million this quarter, increasing our ACL coverage to 1.52%, up from 1.47% at the end of the first quarter, with the increase directed to the general office portfolio.
We repurchased $256 million of common shares in the second quarter and delivered a strong set one ratio of 10.3% up from 10% in the first quarter.
And our tangible book value per share is down 2% linked quarter reflecting AOCI impacts associated with higher rates.
On the next few slides, I'll provide further details related to second quarter results.
On slide six, net interest income was down 3%, primarily reflecting a lower net interest margin, which was down 13 basis points to 3.17%.
with the increase in asset yields more than offset by higher funding costs given the competitive environment and migration from lower cost categories.
With Fed funds increasing 500 basis points since the end of 2021, our cumulative interest bearing deposit data is 42% through the second quarter.
which has been rising in response to the rate and competitive environment and is generally in the pack with peers.
Our asset sensitivity at the end of the second quarter is still approximately 1%, which is broadly stable at the prior quarter.
Our received fixed cash flow swap position is similar to the prior quarter as we held off on adding further protection as rates continue to rise during the quarter.
Moving on to slide seven, we posted a solid fee performance in a challenging market environment.
Fees were a 4% linked quarter, with card fees showing a seasonally strong increase from higher transaction volumes and increases in wealth and mortgage banking fees.
FX and derivatives revenue was modestly lower.
Capital market fees were stable with market volatility through the quarter continuing to impact underwriting fees.
largely offset by increased syndications and M&A advisory fees, despite a few deals being pushed into the third quarter.
We continue to see good strength in our deal pipelines and are hopeful that deal flow picks up in the second half.
Mortgage fees were slightly higher as production fees increased with market volumes, partially offset by lower margins and lower servicing fees.
And finally, wealth feeds were also up slightly, reflecting growth in AUM.
On slide 8, expenses were broadly stable linked quarter as seasonally lower salaries and employee benefits were offset by higher equipment and software costs as well as higher advertising and deposit insurance costs.
On slide 9, average and period end loans were both down 2% linked quarter, reflecting balance sheet optimization actions in CNI as well as the impact of planned auto runoff.
Education was lower given the rate environment, but this was offset by modest growth in mortgage and home equity.
Commercial utilization is down a bit as clients look to deleverage given higher rates and we saw less M&A financing activity in the face of an uncertain economic environment. On slide 10, period end deposits were up $5.5 billion or 3% linked quarter with growth led by consumer of $3 billion.
Borrowing Program initiated during the quarter contributed to reducing flood levels by about $7 billion.
Given our BSO objectives, we grew deposits which drove a favorable mix shift away from wholesale funding. So, that's the end of our presentation. Thank you very much.
As a result, our total cost of funds was relatively well behaved of 38 basis points.
Next, I'll move to slide 11 to highlight the strength of our deposit franchise.
With 67% of our deposits skewed toward consumer and highly diversified across product, mix, and channels, we are able to efficiently and cost-effectively manage our deposits in a rising rate environment.
We increased the portion of our insured and secured deposits from 68 to 70 percent in one quarter. And when combined with our available liquidity of $79 billion, our available liquidity as a percentage of uninsured deposits increased to about 150 percent.
We have increased the portion of our insured and secured deposits from 68 to 70 percent in the quarter. And when combined with our available liquidity of $79 billion, our available liquidity as a percentage of uninsured deposits increased to about 150 percent from around 120 percent in the first quarter.
As rates rose another 25 basis points in the second quarter, we saw continued migration of lower cost deposits to higher yielding categories, primarily in commercial, with non-interest bearing now representing about 23% of the book. This is back to pre-pandemic levels and should stabilize from here.
Moving on to slide 12, we saw good credit results in retail again this quarter and higher charge offs in commercial.
Net charge offs were 40 basis points, up 6 basis points length quarter, which reflects an increase in the general office segment of commercial real estate, partly offset by a slight improvement in retail, primarily due to the strength in used par values.
Nonperforming loans are 79 basis points of total loans, of 15 basis points from the first quarter reflecting an increase in general office which tends to be lumpy.
It's also worth noting that overall delinquencies were lower sequentially, with retail and commercial both improving slightly.
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 increased our allowance by $24 million, which includes a $41 million increase in pre-general office even after covering charge-offs of $56 million.
Our overall coverage ratio stands at 1.52%, which is a five basis point increase in the second quarter.
The runoff of the non-core portfolio, primarily auto, facilitated the reallocation of reserves to free.
The reserve coverage in general office was increased to a strong 8%.
On slide 14, you'll see some of the key assumptions driving the general office reserve coverage level, which we feel represent a fairly adverse scenario that is much worse than we've seen in historical downturns. As mentioned, we built our reserve for the general office portfolio to $313 million this quarter, which represents coverage of 8%.
In addition to running a number of stress scenarios across the general office portfolio, we continuously perform a detailed loan level analysis that takes into account property specific details such as location, building quality, operating performance, and maturity.
We have a very experienced tree team who are focused on managing the portfolio on a loan by loan basis and engaging in ongoing discussions with sponsors to work through the property and borrower specific elements to de-risk the portfolio and ultimately minimize losses.
Our reserves reflect this detailed view of the portfolio as well as the key macro factors we set out on the page.
The property value, default rate, and loss of parity assumptions we are using to set the reserve are adequate for the risks we currently see and are significantly more conservative than what we've seen in previous pre-down turns.
It's worth noting that the financial impact of any further deterioration, beyond what we expect, would be very manageable given our strong reserve and capital position.
On the following slide 15, there are some additional disclosures we are providing this quarter to give more detail on the type and location of the General Office portfolio. You can see out of the $3.9 billion General Office portfolio, 94% is Class A or B with a majority in suburban areas.
which seem to be performing better than central business districts. On the bottom left-hand side of the page, it highlights that the portfolio is quite diversified across geographies as well as the top 10 MSAs listed on the bottom right-hand side. Broadly, for New York MSA, we are starting to see return to office trends picking up.
More than 80% of the portfolio is outside Manhattan where property dynamics tend to be more favorable Washington DC is 100% Class A and D and 95% suburban Moving to slide 16, we maintain excellent balancing strength. Our step 1 ratio increases to
to 10.3% as we look to add capital given the uncertain macro and regulatory environment. We returned a total of $461 million to shareholders through charity purchases and dividends.
Turning to slide 17, you'll see that our set one ratio is among the highest in our regional bank peer group. We see daily
This strong capital level reflects a relatively conservative approach to the IPO in maintaining robust capital levels. If you incorporate the removal of AOCI opt-out, our adjusted set one ratio would be 8.5 percent And we also expect that this replaces us near the top of our peer group again this quarter.
We expect to maintain very strong capital levels going forward with the ability to generate roughly 20 basis points of Set 1 ratio post-dividend each quarter in 2H23 before share buybacks.
So, as you see, we've been focused for a while on playing really strong defense with a focus on capital, liquidity, funding, and maintaining a prudent credit risk appetite.
And that's the job one, even long before the turmoil we saw in the first quarter.
But we also recognize the need to continue to play offense. We need to be selective, investing in initiatives that will grow the franchise where we have a right to win. Over the next few slides, I'll spotlight a few of the exciting things we are doing to make sure that we can deliver growth and strong returns for our shareholders.
First, on slides 19 and 20, we were excited to announce a few weeks back that we have hired about 50 senior private bankers and 100 related support professionals who are with First Republic. As many of you know, for a number of years we've had an interest in growing our wealth business, both organically and inorganically.
So we made a number of investments on the organic side, hiring financial advisors and converting that business from a transactional business to a very customer-centric financial planning approach.
That's got a slow and steady build over the years. And then we supplemented that with the Clark-Bolt acquisition a couple of years ago, and that's gone incredibly well. It can give us a better build.
So, with our customer-centric culture, our financial strength, and the full range of products and services we offer, we were the perfect fit for these bankers. We really admire their approach to delivering the bank to their customers in a unique way with White Glove Service.
This is really a coast to coast team with a presence in some of our key markets like New York, Boston and places where we'd like to do more like Florida and California.
In fact, we think the overlap with J&P in San Francisco is extremely complimentary.
These bankers serve the types of customers we are seeking to attract to the bank, high and ultra-high net worth individuals and families, often with strong connections to middle market companies with a particular focus on private equity and venture capital firms serving the innovation economy. We have a great deal of work ahead of us to integrate these teams.
and to ensure that they are positioned to deliver the bank to their clients. We plan to open a few private banking centers in key geographies and build appropriate scale in our wealth business with ClarkDot as the centerpiece of that effort.
We think this is going to be extremely attractive from a financial perspective. These teams and their staff, about 150 people in total, onboarded late in the second quarter with revenue beginning to ramp in the fourth quarter. Financial impact for the second half will be 8 to 10 cents of ETS plus an initial notable cost of about 3 cents for 2023. These bankers have hit the ground running and are out working to build their book of business.
and we expect the effort to break even around the middle of 2024.
By 2025, we expect EPS accretion of roughly 5%, with 2025 year-end projections of about $9 billion in loans, $11 billion in deposits, and $10 billion in assets under management.
So overall, a very exciting advance for us.
Now let's go to slide 21 and I'll walk you through how we'll be managing our balance sheet over the next few years.
Since the IPO, we've prudently grown our balance sheet while managing the mix of assets and funding with an eye towards maximizing returns.
With the increase in rates since the end of 2021 plus the advent of quantitative tightening and more recently the heightened competition for deposits, we are entering the next stage of the journey with a plan to focus on attractive relationship lending while lowering our LDR which will improve our liquidity profile and benefit returns.
In order to make this effort clear and show the benefits we expect, we've established a $14 billion non-core portfolio, which is comprised of our $10 billion shorter duration indirect auto portfolio and lower relationship purchased customer loans.
This portfolio will run down fairly quickly with about $9 billion of runoff expected by the end of 2025.
Moving to slide 22 and 23, you'll see that as the non-core loan portfolio runs down, this allows us to pay down higher cost funding and redeploy capital into more strategic lending and their investment portfolio. We will also be growing relationship-based lending through the private bank and raising deposits to self-fund that growth. Despite the size of the runoff portfolio, we have set to see modest loan growth in 2020.
where some really exciting things are happening. With the bridge convergence behind us, we have full steam ahead, working to serve our customers and capitalize on opportunities.
We continue to be encouraged by our early success.
We've seen strong sales in the branches as we leverage our full customer service capabilities to drive some of the highest customer acquisition and sales rates in our network.
Most importantly, we've seen a steady improvement in our net promoter scores. On the commercial banking side, we've got a strong new leadership team in place with local talent joining from larger firms and we are seeing some early success leveraging our new visibility to build pipelines for middle market firms.
And we are looking forward to what we can do with our new private banking capabilities in the market. On slide 25, we have a great opportunity to build on Citizens Access, our national digital platform that has been focused on deposits for the last few years.
We've moved to a modern, fully cloud-based core platform, and we plan to add checking capabilities later this year. On the road, we plan to converge our legacy core system with this modern platform.
We are confident that a single integrated platform will be more cost efficient and flexible in meeting our clients needs.
We aim for this to be a complete digital bank experience to serve customers nationwide with a focus on the young, mass affluent market segment.
And on the right side of the page is Citizens Pay, where we have been very innovative in creating distinctive ways to serve customers. Citizens Pay has been the top customer acquisition engine for the bank with very high promoter scores and this has been a great performer from a credit perspective.
We have had some fantastic partners on the platform for a while, such as Apple, Microsoft, Best Buy, BJs, and Diven. We are always very excited to welcome new partners like Peloton, Shrek, the Tile Shop, and Wifetact to the platform.
On slide 26, I'll highlight how we are positioned to support the significant growth in private capital. Over the last several years, private capital fundraising has led to record deal formation of an A activity and substantial fees.
Deal activity has been relatively muted recently and many sponsors have not deployed meaningful amounts of capital. So there is a tremendous amount of pent up demand for M&A and capital markets activity.
We have been executing a consistent strategy to serve the sponsor community with distinctive capabilities for the last 10 years, and we've done a great job moving up to the top of the sponsor lead tables, particularly in the middle market.
We have made significant investments in talent and capabilities, including five advisory acquisitions since 2017. And our new private bankers significantly expand our sponsor relationships and capabilities.
Our success supporting private capital has been a large part of our strong capital markets performance over the last few years. And we are poised to capitalize on the next wave of sponsor activity as the path of the economy becomes clearer.
Let's move to slide 27 for an update on our TOP program. Our latest TOP-8 program is well underway and progressing well. Given the external environment, we have decided to augment the program to protect returns as well as ensure that we can continue to make the important investments in our business to drive future performance.
We have increased our targeted benefit by $15 million to $115 million by accelerating some of our efforts to further rationalize our branch network and reduce procurement costs. We have also begun planning for a top nine program looking for efficiency opportunities driven by further automation.
and the use of AI to better serve our customers. We are also looking at ways to simplify our organization and find even more savings in procurement.
Continuous improvement is part of our DNA and I'm very confident that we'll continue to deliver these benefits to the bank.
Moving to slide 28, I'll walk through the outlet for the second quarter for citizens, which excludes the impact of the private bank, and I will also provide some comments for the full year.
The outlook takes into account another rate increase followed by Fed on hold for the remainder of this year. For the third quarter, we expect NII to decrease about 4%.
Non-interest income to be up by approximately 3%. Non-interest expense should be broadly stable.
Net charge-offs are expected to be broadly stable to up slightly. Our Set 1 is expected to rise modestly from 10.3% with additional share repurchases planned, which will depend upon our ongoing assessment of the external environment.
Relating to the full year, our liquidity position is quite strong and given the BSO actions I discussed earlier, we will continue to build on this, targeting an LDR of low to mid 80s by the end of the year, positioning us well for anticipated regulatory changes.
Worth noting, we already are fully LCR compliant with Category 3 bank requirements.
Based on the full curve, we are expecting a terminal interest-bearing deposit beta of 49-50%.
Our net interest margins should begin to stabilize in Q4 as the Fed is expected to reach the end of the rate hike cycle.
We are off to a great start of building up a private bank and we expect the ETS impact of this to be $0.60 in the third quarter and $0.2 to $0.04 in the fourth quarter. So we really think of this as a capital investment.
To wrap up, our results were solid for the quarter as we continue to navigate a turbulent external environment. To wrap up, our results were solid for the quarter as we continue to navigate a turbulent
We are focused on positioning the company with a strong capital, liquidity, and funding position which will serve us well as we continue to navigate a challenging environment ahead.
Our balance sheet strength also positions us very well to focus on our strategic priorities to continue to strengthen the franchise for the future and deliver attractive returns. With that, I'll hand back over to Bruce. Okay, thanks, John . Alan, let's open it up for some Q&A. All right.
And thank you. Thank you, Mr. Manson. We are now ready for the Q&A portion of the conference call.
If you'd like to ask a question, please press 1 then 0 on your telephone keypad. You'll hear an indication you've been placed into cue and you may remove yourself from the cue by repeating the 1 then 0 command. If you're using a speakerphone, we ask that you please pick up your handset and make certain your phone is unmuted before you pressing any buttons. Again, for questions
Your first question will come from Scott Seifers with Piper Sandler. Go ahead. Good morning, everybody. Thank you for taking the question. I guess the first question is just on the sort of accretion to the margin from the balance sheet optimization. Do you have a sense for what sort of a steady state margin from citizens might look like after that?
I guess it doesn't necessarily have to be a specific number, but just in your view, how powerful is that accretion from these activities? And I appreciate the backdrop of the 4.2% yield versus the 5.5% funding cost.
Yeah, I'll go ahead and start off, Scott. Thanks for the question. I mean, I think that broadly, you know, we're seeing the impact of the rate environment on our net interest margin. We're managing it quite well as the Fed is continuing on its hiking cycle. And as you get into the end of the year, taking into consideration all of the balance sheet optimization activities, we see NIM flattening out and kind of holding in around 3% or so as you get to the end of the year.
And also you can't ignore the fact that the private bank itself, as you get out into 24, will start to deliver a creative NIM. So we're feeling good about the profile after we get through this last hike from the Fed here in July , watching that NIM start to stabilize as you get into the end of the year.
Okay, perfect. Thank you. And then is it possible to put sort of a finer point on the, I guess, 8 to 10 percent, pardon me, 8 to 10 cents of cumulative expected EPS drag from the private bank initiative? I certainly appreciate the sort of the loan and deposited asset management or assets under management outlooks. But maybe any...
Broad sense for dollar value of expected revenues and expenses as we look into the 2nd, that. Yeah, and it's a little bit front end loaded as you as the expenses will come in and drive probably more in the neighborhood of 6 cents of that 8 to 10 happening in the 3rd quarter with the 2 to 4, you know, really into the 4th quarter. And it's primarily expenses in the neighborhood of 40Million dollars or so, you know, as you get into the 3 Q and 4 Q and yet.
expensive, with very long tangible book value earnbacks, many times would be over five years, which is beyond our appetite. So to actually do this in a kind of de novo build-up basis, you incur some capital expense.
in the short run, but it's almost the same as if you kind of equate it to an outlay that ultimately starts to generate revenues. And the nice thing about this is that it's accretive already in the second year, and the kind of earnback on this thing is under two years.
You know, we look at it really less as a driver of how does it affect the near-term EPS, but look, there's a capital outlay which we burned some expense dollars to get it off the ground, and then all of a sudden it's making us money and it really ramps very nicely and can achieve something like a 5% accretion in 2025, which is...
kind of within two and a half years. In the second year of doing a deal, if you compare that to some of the other transactions that we've done, including the bank acquisitions, it's pretty darn powerful. So very excited about this opportunity. Perfect. Okay, good. Thank you very much.
Your next question will come from the line of Erika Najarian with UBS. Go ahead. Hi. Good morning. John , I was just wondering if you could help us with lots of the moving pieces that are sort of unfurling in front of us. How do you spöre?
I guess the first question is, you noted stability at the 3% level. Does that mean that fourth quarter 2024 will be at about the third quarter level? I'm just wondering how those dynamics play out in terms of...
what you expect for the balance sheet trend for the rest of the year, or will the runoff continue to pressure it at that level? What does that fourth quarter NII look like from a range perspective?
Yeah, I think from an IMIS standpoint you're talking about 23, just confirming, Erica. That's 23. I'm building up to 24, Ron. Yeah, I know, I heard you reference 24. But the answer is actually a little bit similar. But what we do see...
is after the Fed hikes here in July and the impact of that burns in in the third quarter that we do see new flattening out there between 3Q and 4Q, having a more flat profile as you get into the end of the year around 3%. So
Maybe a touch higher in 3Q net interest margin, but seeing that profile begin to flatten out. And I think the key drivers of that, the pieces and parts, as I mentioned, we're starting to see deceleration in deposit migration.
in negative deposit migration. So that's a good early green shoot that's consistent with the fact that our DDA levels are basically where we were back to pre-pandemic. And so that ends up being an expected landing zone as you get into the end of the year. So we'll see that flattening out.
You'll see the tailwinds from the runoff book start to kick in, the reallocation of that capital and liquidity into relationship lending and the ability to pay down some higher cost funding as you get into the end of the year. And so that starts to bolster net interest margin.
which we do think carries into 24, and we think that there are a number of positive developments in 24 that would allow us to hold that NIM out into even beyond the fourth quarter. And I would I would comment Erica that you know this was a really important quarter for us to kind of get the deposit level where we wanted.
to get the federal home loan bank borrowings lower and really take a big step in lowering the LDR. And so we paid up a little bit to achieve that. And the impact of that full quarter effect affects the third quarter guide. But I think at this point we feel that...
We don't need to continue to really aggressively grow deposits. We can have a more stable deposit profile, which as John indicated, less migration from non-interest-bearing to interest-bearing. And so there won't be kind of a full quarter impact of an aggressive plan that affects Q4 from Q3 because...
we'll be kind of looking at a more stable profile in Q3. Got it. And so, thank you for that, Bruce. So, as I think about the fourth quarter, is it fair then to say that your guidance implies an NI of 1.52%?
billion for the third quarter. So do we assume that we're at or around that range for the fourth quarter? And you know as we think about you know the puts and takes of 2024 and John I have to bring this up because a few investors were noting I think now it's slide 31 where you have some swaps rolling off and have very heavy
weighted average fixed grade that you're receiving. So as I think about 1.52 billion perhaps as a starting point plus or minus, I assume that your guide for down 100 basis points, NII for full year down 1.2%,
is still valid if we assume rate cuts next year and includes those swap roll-offs. So that's sort of the first question. And the second is how does balance sheet optimization impact that sensitivity? So I'm assuming that's extraordinarily static. So and I'm assuming that from both sides are paying off more debt next year as you were waiting for these loans to come on.
And then as you wait for these loans, you're also putting it in higher yielding cash. So if you could just help us think through the moving pieces as it relates to that original disclosure because I think investors are thinking about the potential for rate cuts next year. Maybe I'll just start off in a couple of areas just when you think about it.
and net interest margins stabilized. So we think the NII is also stabilized at solid levels. So that was, I think, the first question that you had. I mean, I think the- Just to put a point on that too, is that any SWOT impacts are in our forward guides, Erica. So we've already contemplated that. So there's nothing-
rate rise, which we're about to get from the Fed, does actually contribute to NII and net margin for us. So from that perspective, all of that has been built into the commentary that we've been giving you in terms of swap roll-off and our ongoing positive asset sensitivity. So again, when you get.
When you think about net interest margin over, you know, kind of the next several quarters, we have a number of tailwinds. You've got flattening out, non-interest bearing migration, so that's no longer expected to be a big headwind. You've got the runoff book that we talked about, and that runoff book is going to be...
rotated into relationship lending at higher yields. So the runoff focus... And paying off high cost debt. And paying down high cost funding, right? So where we have a negative, you know, kind of spread situation there. We already mentioned the fact that the private bank is going to start.
contributing to the balance sheet later this year and the net interest margin on that is actually accretive to the overall legacy bank. The other thing I threw out there is that just the front book, back book dynamics where you basically have originations in the front book.
Just in the securities portfolio alone, there's 300 basis points plus positive front book, back book in terms of them. We're actually creating a bigger securities book, but we're doing it at the right time where securities yields are actually historically quite favorable. We're putting a lot away from that standpoint.
And we're seeing back into the loan book spreads on our front book originations higher than they were. And you know for example in CNI you know spreads are up 50 basis points over the last year, year over year. So that's also a tailwind.
And, you know, all those things are the things that are going to help us manage the fact that, you know, manage the rate environment and the other items that we have. So I think what John described, Eric, is a number of tailwinds that should be positive. So if the Fed is cutting next year, that potentially is a negative, but we'd have these positive things to offset that, which gives us kind of that stable view into 2024.
Just to wrap it up, because I got a few emails to clarify, and I'll step aside, it sounds like your sensitivity hasn't changed. Whatever that fourth quarter number is, which is stable to third quarter, the down 1.2% down 100 is still valid.
But then the balance sheet optimization will get you closer to stable despite Fed cuts. Yeah, I agree. So balance sheet optimization plus the fact that if rates begin to fall, if they do, we don't have that happening in the fourth quarter, by the way. We have that happening in 24. We have the Fed on hold for the rest of the year.
We have the Fed just based on the forward curve right having the Fed ending around 4% in 24 So it's really not till 24 where you see those down down rate scenarios and in the down rate scenario I mean, you know, that's where deposit micro deposit betas start working for you rather than against you And so then you start getting some of that coming in
As well as the fixed loan portfolio that creates a buffer when rates start to fall. And so I would just add those two things to all the other tailwinds I already articulated as to why we feel like we can hold a stable NIM. Yeah. I just suppose, and you've got an extended period of time here, Eric, and we're very interested in NIM, which I'm sure is on a lot of investors.
a transition period this year and even into next year. It's a little hard to give you full guidance at this point given a lot of uncertainty still in the market. We're giving you our best instincts at this point on that. But I feel quite confident that as we kind of emerge through 24 and then even look out to 25 that
on behalf of Matt O'Connor. Just one question for me. So the capital build was good this quarter with the CET1 rising to 10.3% from 10% and guidance calls for this to increase again in 3Q. Just wanted to ask how high are you willing to let the ratio get to?
I think it's Bruce. I think by the end of the year we could see it getting to ten and a half which you know is a bit above our stated range had been nine and a half to ten.
I think given all the uncertainty that's out there in the economy, plus direction of travel from regulators, that managing it up like that is sensible. Having said that, we're still generating quite good returns, which gives us the ability to nudge that up from here.
terms of the ratio, but also repurchase our stock, which we think is great value at the current pricing. So that's how we're looking at it. And then as we go through 2024 at this point, our early thoughts would be kind of more of the same, that we can at least hold that 10 and a half and maybe build on it based on what we see from regulators. But.
with RBC. Go ahead. Good morning Bruce, good morning Jen. Morning.
Bruce and John , can you guys share with us, obviously, Vice Chair Barr has come out with a speech last week talking about RWA increases that will lead to higher capital levels for all banks over $100 billion in assets. Have you guys given some thought on where this could be, where you could be most impacted by the new Basel III?
possibly as soon as next week.
Let me start, I'll quickly flip it to John . But clearly, I would say there's mixed views on whether that's a sound proposal at this point. And I think the industry itself has acquitted itself very well through the pandemic, through this period of turmoil in the first half of the year.
And I think many folks have commented that the industry has strong capital. And so, you know, in response to three idiosyncratic bank failures, is it appropriate that the thing that needs to be fixed is more capital in the banking system.
I don't know, I question whether that's appropriate and we'll see how it plays out. I think there'll be lots of dialogue around that. I think from our standpoint, by moving our capital position higher, we're anticipating CLOSING counselor hammered a FR Player transfer
any of what could come down the pike is something that we can absorb. We're in a very strong position relative to our SCB, which by the way, we're still have some questions about how it landed where it did, but nonetheless we're well above that and we're well above if the AOCI filter goes away, we already have sufficient capital to meet our new proposed SCB.
So we're in a position of strength, Gerard. I think we can still deliver the kind of returns we aspire to over time as we get through this transition period and hit our medium-term financial targets. But I would kind of at least comment that I'm not sure that that's the answer when we had a series of management supervisory failures.
and poor asset liability management. That really was the problem that caused this turmoil, not a lack of capital in the banking system. So I'll get off my soapbox and I'll pass it over to John . Yeah, I agree with all of that. And I think the issue is in credit RWA versus operational risk RWA, Gerard. So I think there was a view that there would be some puts and takes on the credit risk RWA and maybe it wouldn't be much of an increase expected at the regional bank level. But I did see, we did see those reports on residential mortgages. We'll see how it goes.
a little more than most. So from that perspective, we feel pretty well positioned for the uncertainty of the regulatory rule making process. And as you heard from Bruce, we're growing capital into the end of the year. And I think a 10 something in the neighborhood of 10.5% set one.
is a pretty strong, you know, mitigant to anything that might come down the road from the Fed.
you know, mitigate to anything that might come down the road from the Fed. Great, thank you guys.
Your next question will come from the line of Ken Houston with Jefferies. Go ahead. Hey, thanks. Good morning. I just wanted to follow up on the strategic remixing. And wondering, can you give us some color on the types of loans and deposits that you think will come over as part of that?
those new hires in the private bank. I mean, obviously the first Republic mix had been kind of low rate mortgages and high rate CDs. I would expect that's not the type of name you're looking to be adding. So just wondering just, you know, what those producers you're expecting to bring over and.
And also kind of, you know, we could see it in your AUM expectation, but it looks like it would be more NII delivering as opposed to fees. Let's turn that over to Brendan. Yeah, so, yeah, we are really excited, obviously, about this initiative. And it's a very strategic acceleration of our wealth management business, but to your point, it does come with a lot of different things.
scaling up the bank as well. While we are aiming to recreate a lot of the customer experience magic that existed in these private banking models, we are going to make some structural changes to make sure that the profile of the business that we get is accretive at the top of the house. So what you can expect from us is disciplined credit pricing that while we'll be competitive, we're not going to.
kind of lead with undercutting the market and pricing to make sure we have the right margin. We will have incredibly disciplined credit appetite. We don't expect to take a step forward or a step in the wrong direction in terms of credit risk profile. In fact, we think this will enhance the credit risk profile with very low risk loan generation. We are going to ensure that we're driving lendable deposits on the balance sheet that we put out relative to the private bank, that we're getting core operating deposits, whether that's from individuals or from individuals.
on things like NIMS. So the balance sheet on the deposit side certainly will have a mix of cash management operating deposits as well as interest bearing but we are going to tether all relationships to being primary banking, whether it's corporate or whether it's personal. So you can expect a low cost DDA to be mixed in with interest bearing for help.
Really the large asset classes are going to be mortgage, home equity, and eventually partner loan program where putting capital out to individuals to engage as a partner in a higher end consulting firm or private equity firm, very traditional low risk assets that dislodge the operating deposits and ultimately lead you to AUM. We actually put on a team called financially ready. We have been Bra Project and a civil god thousands of dollars in sales there over the years have been going down and then brought out the first big cashflow investing heavily from AUM, and then we're wrapping up with these
As was mentioned earlier, the profile of the team we got over does have a bent toward the innovation economy. So we're expecting, you know, capital call line lending to dislodge operating deposit relationships with private equity and venture. And a small segment where it's appropriate relationship.
So it's a very integrated end to end business model and we feel like we've got the right recreation of the service strategy married with the right corrections to the business model to ensure we get better profitability and also a stable business model that can withstand the test of time. We think we can do really good growth around this but we will control the growth with a rich presence at least in thereek industries that we have gotten Toparte. This is going up and we are really aiming at some of the most accurate Cure Worries
dig in and just let us know how you previously had done a lot on the commercial portfolio and I'm just wondering have you done it and you keep currently deep diving into the CRE book as you've talked about on the credit side what might there still be to do on the commercial side of the portfolio in terms of you know BSO from that perspective thanks. Yeah I mean I think and as you know in this portfolio that we've set up that's it's entirely a retail portfolio in terms of that 14.
billion but there are nevertheless in parallel BSO activities continuing in the commercial side and let Don talk about that. Yeah so we've been we've been at this for probably three or four years now as we just prune out relationships where we haven't been able to achieve the cross-sell that we've achieved when we were going into the credit several years ago so it's
It's really an ongoing effort. It's been running about a billion dollars, you know a year and we probably Will be running about that same place pace The good news is we've been able to replace some of that with growth in places like New York Metro where we see You know a good a good amount of opportunity on a full wallet basis Particularly in the middle market as we bring on these new hires on the on the Cree side as everybody knows There's not a lot of liquidity But there is some liquidity and we're actually moving some of our exposures after the agencies and then do some most
through some private capital also. So we'll try to liquefy, create particularly multi-family over the next couple quarters, couple years to the best we can and bring those overall exposures down, even though they're performing pretty well. Good. Okay, thank you very much. Your next question will come from the line of John Pincare with Evercore. Go ahead.
Good morning. Just on the capital side, I heard you in terms of the CET1 trajectory from here and that it does still allow for some repurchases. Could you help us frame out what's a reasonable pace of buybacks? We should assume that somewhere
to the 250 million that you did this quarter? Yeah, I would say, you know, that is something we felt comfortable with in Q3. We were going through the, you know, or Q2, we were going through the CCAR process at the time, but we...
saw the opportunity to build kind of have our cake and eat it to build a build a ratio while also repurchasing shares and I think we'll still be in that position so we we still have non-core kind of rundown working for us which is releasing RWAs so you should again have a chance to somewhat eat your have your cake and eat it too both in Q3 and Q4.
Okay, thank you, Bruce. And then on the non-interest bearing mix, stabilizing at the 23% near the two key level. Now what gives you confidence in the stabilization? I know you mentioned you're not pushing as aggressively. You don't see the need to now on competition on pricing. Is there anything though beyond that in terms of the positive behavior that you're beginning to see?
that gives you that confidence that this is where it's bottoming. Yeah, I think there's two items that we look at. One is just the, you know, as we are getting back to the historical place that the platform generated, you know, non-interest bearing pre-pandemic.
And so that's been a sort of a foundational spot that we think creates some solidification of the operating accounts in both retail and consumer. So that's one really important spot. So around that 23% level is about how we see it.
decelerating. And then we have a number of I would say activities on the product and low-cost strategy front that that you know we're seeing some really positive uptick on in retail in particular and so you know. I want to ask Brendan to pick up and add some color. Yeah a couple of a couple of quick points just a quick recall as we've talked over the last whole bunch of quarters.
The consumer portfolio has been under a five, six year transformation for quite some time and is in a very, very different starting point through the beginning of this cycle than ever before for this franchise with significant improvements in things like customer primary, privacy, growth in households, our mass affluent mix has improved and low cost deposit profile has moved.
So coming into the cycle, we were very confident that we'd be more peer-like or maybe outperform. And data that we're seeing with benchmarking suggests that in the consumer bank, we are indeed better than average versus peers right now on all dimensions, interest-bearing cost, beta, as well as low-cost control. So we feel pretty good how we're performing against peers.
still having some modest outflows and rotation into interest bearing as well as rotation outside of the banking industry. So year over year, the wealthier segment is down about 10%. We're seeing the massive fluence segment in deposits on a per customer basis above flat. And the mass market portfolio is actually increased in net deposits. And that's a function of a lot of our strategies that we've put in place to really drive primacy and activity and engagement. And so we've seen a bit of a bottoming at the lower end.
very operationally oriented, but it actually is a dramatic improvement to things like primary banking behavior, which drives low-cost deposits. We've made overdraft reform through our peace of mind 24-hour grace program and a variety of other things, which has also driven a lot of primacy. And we're starting to really rev up the engines on household growth overall. All of those things contribute to some controllables. So I think we're outperforming peers on the market.
given our starting point in the cycle and we're continuing to invest to try to further outperform through all of these different initiatives and strategies. It is not the long game. These are driving primacy and low-cost deposits. It takes a while to build up scale, but I feel like we've got a lot of the right things in place in addition to outperforming on our back book to win the game uncontrollable where we're at right now.
It's a combination of just the growth in the cash management business overall and bringing on more clients on the cash management side. As I said, in New York Metro, the things that we're adding are really full wallet, full cash management relationships. So those bring really nice deposits. And then on the product side, we've done a lot around green deposits and carbon offset deposits in our ESG.
Thanks. Your next question will come from the line of Manan Gasalia with Morgan Stanley . Go ahead.
Hey, good morning. I appreciate all the detail on the Office book. It looks like you have a pretty conservative assumption based on your CRE office reserve levels of 8%. I guess the question is what would you need to see to take that up even more or
Over the next few quarters, as some of your office portfolio comes up for renewal, should we expect the reserve levels go down as you have more normalized NCOs in that portfolio?
and John or Don can add, but we feel quite good about, A, the overall nature of what we have, and B, then, so there's good diversification, good quality characteristics.
We have some really good people that are really focused hard on this and they're monitoring this loan by loan. They see the upcoming maturities. They get way in front of those. So we're having good dialogue with borrowers. And I'd say we did a good job, relatively good job in the first half of absorbing some of the
and probably about 30 loans I think came up for maturity, which is about the number that we're gonna have in the second half, and it's about the number that we're gonna have in the first half of next year. It's about the number that we're gonna have in the fourth quarter of next year. And if you look at the net result of that, while we have an increase in criticized, we have an increase, this quarter was a little lumpy in NPAs in this sector, and that probably levels off. I'd say we were able to build our reserve and absorb charge offs. So.
We took 56 million in charge off, so that's another kind of one and a half percent loss content. If you look at the 8%, it's effectively higher by what we just absorbed. And so could we go for another few quarters with absorbing charge offs kind of on a pay as you go basis with what we're providing and fold the reserve flat? Yeah, possibly that could happen. And then at some point, does that tip over? And then you don't need as much reserve because you've burned some of those losses through your charge off line.
Anyway, that's just a little color about how we think about it, John . I don't know if you want to add anything or go direct to Don. Yeah, just to reiterate the fact that, you know, as you mentioned, we took $56 million. That's 1.5% so that, you know, we've got 8% set aside, so that implies a 9.5% coverage.
for the losses through the cycle. And we think that's pretty darn adequate, as a matter of fact, very strong. And so, I think that, you also mentioned NPL's flattening out and charge offs kind of getting in the run rate rather than step change from here, which I think is important to re-emphasize. And maybe just turn it over to Don. No, I think you guys have said it was 26 months, so you're pretty close with 30. It's pretty good that you know that. But I think the thing I'd emphasize is
that we have a pretty good eye to the path of the book as we look forward. And you know, things could always change, but I think we feel pretty comfortable that we've been very conservative based on what we see. And I will emphasize, I mean, we're not originating anything really of any scale in origination. Our whole origination team, in addition to our credit team, in addition to our work app team, is focused on...
working with our sponsors to basically – In the office sector. In the office sector, yeah. And the rest, by the way, the rest of the real estate, both multi-family, industrial data centers, I think it looks like it's holding up extremely well. We're really not seeing any weakness that concerns us at all in the rest of the real estate part. That's very helpful. Thanks for the full Samantha. Just to move on to capital, is there any color you can share on what growth –
we are getting that set up so we can go through and kind of understand their models better. I think that's been one of the concerns of the industry that it's not that transparent to us but kind of when we look at the results there's a there's a couple of things that could have been a factor.
One is the build of the allowance when we took relatively high charge offs, we had a significant build was built into their models which we didn't have in our models and that alone probably cost us 30 basis points of a 60 increase or something like that. So that's one thing that we'll want to talk about and understand better. And then questions about we did a deal and did the.
the one-time expenses get incorporated or we've done a lot of hedging in the falling rate scenario, are our hedges getting full benefits? So we just have some questions that we want to poke at but in any case I think the bigger point here is that we can roll with this eight and a half and we have plenty of capital and we have a
appreciable buffer versus that capital. So it really doesn't affect kind of our capital management strategies, but we would like to see it, you know, get kind of back into line. We think it's a it's a bit elevated relative to where it should be and we'll be having those conversations with the Fed in the coming weeks.
Yeah, I think that as you get past this year where we have those integration expenses and you know there's a hypothesis that that will roll off as you get into next year and we'll have another bite of the apple next year given the fact that we're going to be doing this again and you know in the end the ECB is not our constraint.
Our constraint is our own view of what capital we need to be prudent to support our business and frankly where the Fed and the regulators are headed with required levels outside of the SCB is going to be our constraint. So we're going to be, as Bruce mentioned earlier, about 200 basis points over the SCB by the end of the year and probably heading towards earlier compliance with whatever the Fed comes out with at most.
and return that capital to the extent that those front book opportunities are not there. We probably had the opportunity to do both, where we rotate that capital into relationship lending and provide an ability to buy back. It doesn't have a direct impact on the SED. Great, thank you.
And your next question, one moment please, your next question will come from the line of Vivek Junaidya. Go ahead. Hi, thank you. Just to follow up on the First Republic Banker question, Bruce, Brandon, would you like to
requirements do you have? What are your pricing assumptions? You said you're trying to bring the pricing to yours but then what are the assumptions for what the bankers need to deliver to be able to recoup their or earn their guarantees? And secondly, given that this was a white glove service which was obviously very expensive,
What changes are you planning to make to that to be able to get to your hurdle profitability targets? Yeah, thanks for the question. We already, prior to the lift-up with private bankers, had relationship-based pricing in play in all of our asset classes, including giving an appear of latest investment.
So when you bring heavy levels of deposits in AUM, we price down modestly for that. So we don't have any intention of changing what we already do. And so our new private bankers will have access to the same relationship pricing grids that we've had in play for a while. So as you think about pricing and yields of things like mortgages or even some of the small business commercial lending, we're not expecting a dramatic change in the market
the teams that came over understand that. And so, you know, I'd say the one thing that they won't have in their arsenal is deeply discounted mortgages. But I think they'd come in with their eyes wide open on that and quite honestly, the deeply discounted mortgages are probably now back on your balance sheet because.
So I think the team coming over is very comfortable with that. And another question around expenses implied in the comments that John and Bruce both made around break-evens inside of 2024 is the team's production covering kind of top guarantees to come over. So we've been really thoughtful about how we do that. That obviously we've got the way these folks get paid. It's in a book of business model and they're you need to read a book by James Schaelberg. The topic is how do we prepare for there to refusal by the system by now? Who is going, like, by overeating the actual feature? Yeah, fair enough. I'm just showing you what happens when you pick up those rules. So like you mentioned, you've got the feedback that someone might want, if anybody is a thousand dollars a day or whatever. No matter if it's a run out, the inaccessible crap significant racism may come to you because you'll be where it is, so you'll be really passionate about your organization.
to go out and develop a lot of business and we're gonna give them the runway to do that. We had a lot of debate with them on the appropriate timing to make that happen and make sure the operations excellence is available here at Citizens. The cost of that is considered in all of our guidance and commentary we made about the profitability of the business and we're already well underway on tinkering with the way the bank works to make sure we're creating the conditions for them. And I'd say there we probably had the brakes on a little bit to make sure.
some things that spin off from that that we can move to other parts of the bank without question.
Thank you. And a follow-up for just Don. Don, what are you seeing on the whole sponsor side given with high rates in the market when...
What level do you expect it to come back to even in 24, say, just given if rates stay high? Yes, some cuts, but I don't think anybody's expecting it to go back to where we were a year and a half ago. So any thoughts on what level of activity do you think we get back to? Yeah, we'll see. High level, our pipelines are about 30% higher than they were at this time last quarter. So sorry to say, it's not like a lot you're saying.
We're seeing the pipelines build. Sponsors are certainly engaging in conversations, whether they can get to actual transactions or not. Although there have been some. There was a World Pay transaction that was announced a few weeks ago. So we're beginning to see some transactions. Remember, one of the things that we benefit from, and I've said this a couple quarters, is we tend to play in smaller deals, right? So we're 100 million to 750 million to a billion in terms of deal size, whether it be advisory or financing.
We were number one in the middle market leverage financial elite tables in the last quarter. Volumes were down, but we were the number one institution playing. So we're gaining share for what's available. So do I think we're going to be back to 2021 levels? No. But I think if you get stability in rates.
It's the beginning of deal formation will happen and it'll just depend on valuation dynamics between sponsors and and and sellers and the you know, there's just a lot of Companies in our portfolio that just need to sell they want to sell for generational reasons So there are things that are available deals make it over equitized just to keep the interest burden down if value doesn't come down But we're starting to see a lot of a lot of conversations going so I don't I don't think we're going to be off to The races, but I think it's gonna it's going to continually build and I think 24 could be a pretty good year
Thank you. There are no further questions in queue and with that I'll turn it back over to Mr. Van Sohn for closing remarks. Alright thanks Alan and thanks again everyone for dialing in today. We certainly appreciate your interest and support. Have a great day. Ladies and gentlemen that will conclude your conference.
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