Q2 2019 Earnings Call
Ladies and gentlemen, thank you for standing by your conference will be starting in just a few moments. We appreciate your patience in holding.
Good morning, everyone and welcome to the citizens Financial Group second quarter 2019 earnings Conference call.
My name is John 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 Ellen Taylor head of Investor Relations Ellen you may begin.
Thanks, John Good morning.
Really pleased to have in Florida, We've got a lot of great material to cover in our presentation, which you can find it in that third citizens Bank dotcom.
First this morning, our chairman and CEO , Bruce Van Saun, and John and CFO , John Lewis will walk through our results and our outlook and then we'll be happy to take questions, Brad Conner head of consumer banking and Don Mccree head of commercial banking are here also to help us with that effort I need to remind you that our comments today will include forward looking statements, which are subject to risks and uncertainties and you should review the factors that may cause our results differ materially from the expectations on page two of the presentation in our 2018 form 10, K.. We also utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our earnings material.
And with that British you've got the floor.
Okay. Thanks, Alan Good morning, everyone and thanks for joining our call.
We're pleased to announce another strong quarter today.
We navigated reasonably well through a dramatic change in the rate environment.
Our fee businesses have really come on strong as Weve integrated well, our recent acquisitions and we're able to do more for our customers and our expense discipline continues to be excellent.
We continue to find efficiencies that lead to some sort of processes and better customer experiences. While also creating the wherewithal for funding new growth initiatives.
We're also very focused on being good stewards of our shareholder capital both in terms of loan growth and capital returns to shareholders.
Our year over year loan growth was 4% with a lots going on inside that number we are allocating capital to grow portfolios that offer good risk adjusted returns and attractive cross sell while extracting capital through both sales and wrote off as part of balance sheet optimization.
We are passing on commercial deals in the market, where we don't like the risk the terms are the pricing.
Our deposit growth has been faster than loan growth at 7%, which has the benefit of bringing our loan to deposit ratio down to 94%.
So this is access has been key to this as they reached $5.4 billion in deposits by quarter ends.
This lower LDR gives us increased increased flexibility and funding strategies, which will be highly beneficial in the current uncertain rate environment.
We recently announced a 25% increase in our buyback capacity to 1.2 $75 billion.
And today, we announced the four cents dividend increased to 36 cents per share with dividends now up 33% from the year ago quarter.
I'm excited by the work we've done in developing a significant top six program and also in some of the strategy work around investment opportunities to drive medium term revenue growth.
I'll, let John take you through the details on our slides, but to me. These programs are well designed and should deliver real benefits if executed well.
We want to be innovative nimble and flexible in how we operate we want to up our game, even further and how we deliver for customers and we want to break through on some new revenue pools.
All very exciting and differentiating versus peers.
Our strong first half performance with EPS up 14% reflects our disciplined operating mindset and capability as we've had to grind out results in a tougher environment than expected coming into the year, particularly around the extreme movement in rates.
I think we're well positioned for the second half with strong fees and expense discipline poised to offset rate pressure and Eni and credit still in very good shape.
We will continue to focus on disciplined execution, you can count on that.
So let me stop there and I'll turn it over to our CFO John Edwards.
Thanks, Bruce and good morning, everyone. We are pleased to report another solid quarter with good fee income growth strong expense discipline and consistent execution against our strategic initiatives.
Let me kick off by covering important highlights of our underlying results.
On page four.
We delivered EPS growth of 9% year on year with PPNR up 7%.
Despite a challenging rate backdrop, we delivered net interest income growth of 4% year on year.
Loan growth was 4% and net interest margin was stable at around 3.21%.
We also continue to drive momentum in fee income with 19% growth year on year, 6% excess acquisitions highlighted by record results in mortgage wealth capital markets and card fees.
Our disciplined focus on growing the top line and controlling expenses drove positive operating leverage of around 1% before the impact of our recent acquisitions.
Commercial banking loan growth was 7% and consumer banking loan growth was 3% as we continue to find attractive areas to deploying our capital and grow our customer base.
Strong deposit growth was paced by continued momentum in citizens access.
Our spot LDR improved to 94.2%, providing us with funding flexibility as we head into the back half of the year.
Overall credit quality remains excellent with a stable nonperforming loans loans ratio of 66 basis points and an allowance to loans ratio of 1.05%.
We delivered underlying rasia, 12.9% and tangible book value per share was up 12% year on year, and a 44% linked quarter to 30 point 88 cents.
We finished the quarter with a strong 10.5% CET one ratio.
On page six net interest income was up 1% linked quarter as asset growth and the benefit of day count were partially offset by a four basis point decrease and then given rate rate impact.
Importantly, we have taken significant steps to reposition the balance sheet profile in a lower rate environment.
During the quarter, we opportunistically use hedges to reduce our asset sensitivity from 4.2% to 2.9%.
We shifted the vast majority of our sensitivity on the short end to the long into the curve with 75% of the types of rates longer than six months and about 25% coming from the short end of the curve.
This action was the most recent step and a program that began in the third quarter of 2018 to moderate our asset sensitivity overall.
This was driven in part by increasing our net to see fixed swap position over 50% from around $9 billion in the third quarter 2000, $18 billion to $14 billion in the second quarter 2019.
Moving to fees on slide seven.
As I mentioned, we delivered strong execution in our fee based businesses highlighted by record results in mortgage wealth and capital market as we continue to build out our capabilities and deepen client relationships.
Noninterest income was up 8% on a linked quarter basis and up 19% year over year.
Before the impact of acquisitions noninterest income was up 3% linked quarter and up 6% year over year.
In commercial.
Capital markets fees were up 19% year over year and up 6% linked quarter. Despite a slower market conditions, our businesses continue to perform extremely well paced by a record number of deals and loan syndication, which were up 73% linked quarter.
FX and interest rate product revenues were relatively stable with record first quarter level. Despite the backdrop of uncertainty because many clients to delay hedging.
On the consumer side of the house, well fees were up 13% linked quarter, driven by higher sales volumes and an increase in managed money balances.
Card fees were also a record for the quarter up 8% sequentially driven by higher purchase volumes, including seasonal benefits.
In mortgage banking, we saw nice rebound in the quarter up $19 million or 44% linked quarter, driven by an $18 million increase in production revenue, reflecting seasonally higher originations and a pickup in refi activity.
Servicing revenue was broadly stable given the benefit of hedges.
In addition, we continue to grow the servicing portfolio, which is now over $90 billion.
Turning to page eight underlying non interest expense was up 1% linked quarter, reflecting strong cost discipline and the benefit of our top program initiatives.
Salaries and employee benefits were relatively stable as seasonal reductions in payroll taxes, and 401K . matching costs were largely offset by higher revenue based incentives consistent with the strong fee revenue trends in the quarter.
There was also a $3 million seven stretch.
Outside services increased 7% linked quarter on an underlying basis, reflecting our continued investments in technology as well as costs related to higher consumer loan to deposit origination volumes.
Let's move on to page nine and discuss the balance sheet.
You can see we continue to grow in commercial with a focus on our geographic and industry verticals expansion strategies.
In commercial real estate, we are selectively seeing attractive risk adjusted return opportunities with growth tied to high quality projects largely in office and multifamily.
On the retail side, we also continue to drive growth and attractive risk adjusted return categories like education, refinance and unsecured including our merchant partnerships.
Overall loans were relatively stable linked quarter and up 5% year over year.
These results reflect the planned runoff in auto noncore and leasing as well as a modest headwind from greater than expected asset dispositions types, where our balance sheet optimization initiatives.
Loan growth was 0.4% adjusted for the impact of one Q1 9, and two to 19 loan sales with commercial of 0.8% and consumer of 0.3%.
Going forward, we will continue to elevate loan sales as part of our balance sheet optimum evaluate loan sales as part of our balance sheet optimization initiatives.
Moving to page 10, we're doing a nice job of growing deposits, which were up 2% linked quarter and 7% year over year with stable results in DTA.
We continue to benefit from our citizens access digital platform, which has contributed nicely to our funding diversification and the optimization of our deposit levels and costs.
At the end of the quarter, we reached $5.4 billion in citizens access deposits.
Our total deposit costs were well controlled despite strong growth up three basis points linked quarter, a significant improvement from the 16 basis point increase last quarter.
This reflects a proactive approach to deposit pricing as we have been aggressively managing our deposit costs.
We've reduced CD rates and money market rates in our branch footprint as well as taking down the savings and CD rates and our digital bank.
Year over year, our loan yields expanded 37 basis points, reflecting the benefit of higher rates and the impact of our BSL initiatives.
Our total cost of funds was up 33 basis points, reflecting a shift towards a more balanced mix of long term and short term funding and higher interest rates.
Next lets move to page 11, and cover credit which continues to look quite good.
Reflecting growth in high quality retail loans, and an improved risk profile in our commercial portfolio.
The net charge off rate of 36 basis points was up modestly linked quarter from relatively low level and included a $9 million increase in commercial charge offs.
This is largely driven by a couple of idiosyncratic losses as the broader portfolio looks very good with continued improvement in risk ratings and a continued lower trend in criticized and classified loans, which were down 4% linked quarter and 19% year over year.
Provision for credit losses of $97 million was up from prior quarter and prior levels, reflecting the higher charge offs.
Our allowance to loans coverage ratio remained relatively stable ending the quarter at 1.05%.
The NPL coverage ratio was relatively stable at 159% as we saw improvement in npls and runoff in the non core portfolio.
On page 12, we maintained our strong capital and liquidity position ending the quarter with a CET one ratio of 10.5%, which compares well with peers and gives us excellent financial flexibility.
As you know, we recently announced a new share repurchase authorization under our 2019 capital plan of up to $1.275 billion and this resent represents a 25% increase over last year's authorization.
We also increased our quarterly dividend by 13% to 36 cents, a share which reflects a 33% increase from a year ago, and we continue to target a dividend payout ratio of 35% to 40%.
Our planned glide path to reduce our CET one ratio remains on track.
On page 13, I want to I want to highlight a few exciting things that are happening across our bank first we are extremely proud to have been ranked number three of the top 40 banks in the country for our reputation among consumers in the 20 mentioned in American banker reputation Institute survey.
Note that we moved up 12 positions the largest move of any bank, which is a real testament to what our colleagues do every day to help our customers reach their potential.
Next we have launched a suite of digital tools that transformed the end to end mortgage customer experience and help us operate more efficiently.
In commercial we are pleased to introduce access optima, our best in class cash management platform that is now available to new clients.
We are migrating current clients to the platform over Q2 to Q4.
Let's move on to page 14.
The tapping our essential or top programs have been instrumental in driving efficiencies that allow us to self fund investments and continued to deliver future growth.
We have executed very well on the top five initiatives, which are expected to deliver 95 to 105 million pre tax by the end of 2018.
We are now pleased to share some of the early details of our top six program, which will consist of two parts.
The first being the transformational program, which is designed to transform how we operate and deliver for customers and colleagues.
We aim to deliver a more customer centric efficient and agile environment by modernizing our cross organizational operating model and 19 practices by accelerating migration to the cloud by more ambitiously utilizing data and artificial intelligence and by digitizing end to end processing.
The second part will consist of a more traditional top improvement program similar to those that we that we successfully executed over the last five years.
Importantly, the benefits of the program will help to mitigate the headwinds from interest rate maintain our commitment to delivering operating leverage and improving our efficiency and rusty.
We also expect to utilize some savings to fund a net PML investment of up to $50 million over 2020, and 2021 for potential strategic revenue opportunities such as.
Significantly expanding digital strategies across the company to reach more customers.
Reinventing the payment experience at point of sale.
And launching new commercial customer digital offerings.
We are developing detailed plans for each and we'll keep you posted as we make progress.
These investments should really benefit benefit our medium term revenue growth over 2022 to 2025 is executed well.
On page 15, we provide additional details around the focus of the top program, including early days financial targets.
We are targeting run rate savings from the transformational program of $100 million to $125 million by year end 2020, and savings of 200 to 225 million by year end 2021.
The traditional program is expected to deliver $75 million to $100 million by year end 2020, and over 100 million by the end of 2021.
The combined total is $300 million to $325 million in run rate benefit by the end of 2021.
Note at the bottom of the page the top six is expected to create the capacity to absorb some of the startup costs of our strategic revenue initiatives.
We have some really bold ideas that we'll have to see the level of investing with the near term external environment.
They also point out that there will be onetime costs associated with our program. So the payback ratio is highly favorable.
Note also that we do not expect to announce the top seven next July we currently believe top six open and add to it as we go over the next two years.
Our outlook for the third quarter is on page 16, and it reflects continued good positioning for both our top and bottom line results.
We expect net interest income to be broadly stable in Q3 as modest loan growth should offset the NIM NIM contraction due to rates.
We are expecting noninterest income to be up modestly similar to the trend we saw in the third quarter last year.
Given our continued focus on expense discipline, we expect non interest expense to be broadly stable.
Additionally, we expect provision expense to be in the range of $100 million to $105 million.
And finally, we expect our CET one ratio to be broadly stable.
Regarding our full year outlook, notwithstanding the meaningful change in yield curve environment, which now factors in a rate cut in July and September we expect our full year performance will track broadly in line with our January for your diet, but there will be puts and takes with lower net interest income offset by better fee income and expense performance.
The provision at the low end of the guidance range.
To sum up on page 17, our results this quarter demonstrate our continuing strong performance as we execute against our strategic initiatives grow customers in revenues carefully manage our expense base deploying new technologies and improve how we run the bank and now let me turn it back to Bruce.
Okay. Thank you John .
Operator, why don't we open up for some QNX.
Thank you Mr. van Saun, and ladies and gentlemen will ready for the Q and a portion if you would like to ask a question on the call. Please press star one you'll hear a tone, indicating when placed in the queue. If your question gets to answer any way stream moving yourself from the queue. Please press the pound key again star one exam question.
And first from the line of men O'connor with Deutsche Bank. Please go ahead.
Good morning.
All right.
So the latest top duration I think is a lot bigger than than most expected and obviously it covers a couple of years or a little bit of a longer period, but it's still much bigger I think than what it's been in the past and mix of what was expected.
Can you help frame how much of that actually falls to the bottom line.
As opposed to like offset.
Say core expense growth or inflationary growth right I guess the question as you know we see these numbers, we can make the adjustments on the onetime investments the onetime costs.
How much of that actually boost the pre tax earnings.
Versus helps offset some other dynamics such as rates as you mentioned and the core expense growth.
Well I think that what you've seen historically from us is a commitment to driving positive operating leverage and so the top programs.
Do a number of things for us that give us.
That differential because theyre oriented both towards finding efficiencies in helping expense line, but also finding additional revenue sources and helping the top line. So.
We would expect.
That's the principal commitment we have here, we keep running the bank better we keep serving customers better.
And we have a commitment to continue to drive operating leverage which will improve our GC and efficiency ratio going forward. It's a little hard we're not giving next year guidance on this call. We don't give guidance till January so until we see how the rate.
You know trajectory moves between now and the end of the year I think it's a little premature to make the call on that.
So would it be fair your hope that even in a kind of tougher prolong rate environment as a top initiatives are meaningful enough to get you that positive operating leverage even with a rate headwinds as we think out medium term.
That would be the goal for sure.
Okay. Thank you.
Yes.
Our next question is from mining most be assigning Sparks. Please go ahead.
Good morning.
Good morning. Thanks.
Oh, it will add value with the acceleration of the share repurchase.
Last year, you front loaded a lot of your share repurchase activities.
Are you thinking how is the timing of this year's plan is it going to be even or little bit more and.
2019.
Well I'll start John you can know find but last year.
We did front load a bit we want to still have firepower in every quarter, but certainly.
We think the stock is that.
Suppress valuation so it's a good time to buy some more stops so you'll see us.
Buying stock in.
In Q3, and Q4 at amounts that will be more than you'll see in Q1 and Q2 of next year.
Yes, I think thats I think that coveted venture.
And then you've done a great job of getting these fee businesses kind of built out.
How are you seeing what has been the reasons for your success when others I've had a hard time being able to do this and then how do you see that kind of going forward. What are still areas do you still think that you're going to be able to reap some of the benefits of what you've been investing in.
Sure we can reach it takes a village to answer this one we saw around the table here, but let me start.
And I'd say on the commercial side.
What weve focused on is broadening our capabilities and then also expanding our coverage force and then working as a team to bring thoughtful solutions and value added some clients.
And so thats really gained a lot of traction you can see it across the board we have.
More products to offer to customers more services to offer.
I think we are doing a great job across the board and whether it's the capital markets, whether its M&A, whether it's FX and interest rate hedging, we're hitting record levels of fees every quarter, we're winning.
Jump balls against the Mega banks, we have some really great capabilities.
Lift on add to that but on the consumer side has been a long effort to try to get our mortgage business on our wealth business in particular positioned for growth I think we're seeing that now we had certainly Franklin had a great quarter and our underlying retail a little business had a great quarter. So I think mortgage now is better positioned than certainly it has been there's still work to do in that business, but we feel good about the outlook.
And then also on the wealth business, we've scaled it up we're penetrating our customer relations with I think a very good segment strategy and matching.
Our product and offerings to the needs of the different segments that we're serving we did to the acquisition of Klarsfeld to attack the very high end the ultra high net worth clients as being integrated very effectively we have a lot of flow going in there. So I think across the board.
We feel good about the fee outlook, we think it's sustainable.
We're passing the Baton if you will in a period, where there will be some pressure on eni given race.
I think we can pick up the slack both with stronger fee performance and continued good discipline on expense and then.
I think credits in really good shape as well so why don't we go around the table correctly, John anything to add no I think that that covers automatic that the real emphasis around the organic investments coupled with the bolt ons that we've done in wealth and mortgage have been quite powerful and all the organic investments that have been made in the in the commercial side are starting to pay off with but I'd also add is that.
Not only do we have a diversifying effect across the fee businesses within commercial and consumer, but even within commercial and the cap markets business. The things that we've done there to diversify across M&A advisory and loan syndication.
Where this quarter loan syndications were strong last quarter, M&A advisory and bond.
Unit volumes were strong so you can see that even just within the lines of business as well as across lines of business. So it's really pleasing to see that yes. Don you want to go next third commercial yes, sure I think I think it's been said, but I think the thing that I would emphasize is we've been on this path for years.
We hired a lot of very talented people, we've added that to M&A acquisitions and the way we're integrating the soft clients problems is really unique and as a business is a very long time and I've never seen a team working together. So you couple the capabilities with very long relationships that we've had and we've got very high win rates and you see this if you look at our lead cable results you see is rising and virtually every lead table into.
Very very strong position, so I'll pick up on what John said the thing that I like the most is the diversification is at one market is a little bit we can serve our client and another market and continued momentum on the piece, we feel good about where we are great and Brad lastly, but not least.
Yes, similar to dine in some ways, we have been building this capability for years now I'm talking about and then when I look at the wealth business certainly the Klarsfeld acquisition gives us new capabilities.
But we've been building out our value proposition for our that we've talked for a long time with our heavily weighted on a unit customers in our customer base and we've rebuilt that value proposition, we've been using data and analytics to do much more personalized and targeted offers.
I think thats paid a dividend and then on the mortgage side clearly Franklin American gives us new capabilities.
But we've also been building digital capabilities and I think we're getting to the point, where our digital capabilities are right there with some of the best in class in the industry.
Franklin American gave us much better diversification of origination channel. So I think just a lot of building the right pieces over time has gotten us to a good advice okay.
Thank you.
Thank you.
Our next question is from Erika Najarian with Bank of America Merrill Lynch. Please go ahead.
Hi, good morning.
Hi, good morning.
Good.
Just ask and how would that have on the clarification.
When how we should think about net interest margin.
Behavior.
Under the scenario of July and September early.
And also if we could get a little bit of color on how you're thinking about deposit strategy in terms of pricing.
As we face.
Potential easing environment.
Yes from the start coach on them.
So Erika I think.
We feel quite good about how we were.
Kind of anticipating.
What was happening in the market, we geared up with our top program to start looking at expenses, but then also we got right on the deposit pricing and were very proactive in cutting deposit prices and optimizing across our different channels.
In the quarter. So I think of all the folks we've reported all the banks reported up to now I think we have the lowest increase in interest rates deposit costs of three basis points of anyone who's reported so so that feels quite good.
I think the four basis point contraction in NIM was also shows up very well versus peers and I think it's really reflective of the emphasis we had on the deposit side I think going forward will you know our guidance contemplates that there will be two cuts and so.
We'll have to move through getting through this NIM contraction period, which we'll probably see some more of that in Q3, but then I think we'll start to stable level out after that.
John you want to offer some more color, yes, I think thats right I mean stabilization as you get towards the end of the year I think I think the dynamic that we're seeing is a couple of holes on and you have to deal with.
When we when we started on this whole.
The tightening cycle and we saw.
Deposit betas start out low and begin to build over time. The in period beta is getting the highest as you got into the end of last year and I think that it's our view that you'll see a similar.
Profile in reverse where.
As you see the rate cuts.
Come through the benefit will start off a bit low as the deposit lag dissipate over time and and then you will see the deposit beta to grow.
The same can grow over time, if in fact, the the the aging cycle extends beyond just in insurance cutter too. So thats an important issue you also talked about pricing outside of just how your models work. How do you get ahead of pricing I think that we got ahead of some things.
Throughout the last several months.
Late first quarter into second quarter.
Footprint. We we were we were relatively early in sort of revising our promotional rates and and revising our direct mail campaigns and then you see more even more visibly you see in the citizens access platform were late first quarter early second movie, we became the pullback on marketing and reduced our CD yields earlier in the quarter and then reduce savings you have here in early July . So I think all those actions have started late one Q and into Q Q1 sort of.
Showed up in the in what you heard from Bruce with in terms of interest bearing deposit costs being up only three basis points I'd say more broadly maybe just to even take a further step back and think about what's going on within overall outside of deposits.
We also as you heard in my remarks embark upon.
Our program in the third quarter 2018 to significantly increase our net receive.
Never see fixed swap position and we increased that by over 50% from around 9 billion to around $14 billion on a net basis just dollar cost averaging over time, then we added to that position every quarter in the last three quarters and that loss.
Some other actions, we took to shift out our exposure to asset sensitivity to the long into the curve. So that now when the fed does cut on the short end, we're actually more exposed to the long end of the curve than we are the short end of the curve for the first time in in many many years, so which we think is a smart weighted to the position as we head into these.
Next next next two cuts.
Got it and a follow up to that is there is there are some pieces that from banks that have accelerated interpret our deposit costs on the way up like citizens.
Thank you Steve is that the net interest margin under this scenario if the forward curve, which includes fair form rate cuts between now and 2020 that the net interest margin bottom.
And this year and potentially stabilize if not increase on a quarterly basis and 2020.
As deposit cost free pricing becomes more robust and I'm wondering is that too optimistic.
The thought process for 20, 2020, and just based on the mechanics that you have.
Walked us through or is that possible for citizens.
Yes, I mean, I think as you heard earlier, we're going to hold off on on 2020 guidance here I mean, I think that as just stay within.
2019.
You heard earlier from Bruce.
She is which is right that as you get into the end of the year. There is some stabilization that we expect to see.
In NIM has that deposit lag from the last hike in December dissipates and as the pricing lag relate really burns off.
You will see that dynamic happen and therefore, we do expect deposit beta.
The deposit beta for the second cost to be higher than the first meaningfully higher and we'll see how that all plays out on what the rate environment looks like and how we have to also build and what competition for deposits are and and how we're how we're growing that growing the balance sheet all of those all those dynamics play into the overall NIM outlook initially heard from US earlier, we're looking to keep an eye on broadly stable into the third quarter as we're playing off.
Loan growth against our our net interest margin profile. So I think thats, how I just I guess Erika to your point I'd, just add that while that might create some relative.
Performance benefits, we're still asset sensitive so I think we're better off if we just see a couple of cuts here.
And then the fed.
Kind of.
Creates the stimulus to keep the expansion going and then they stop that would be I think a preferable scenario from from our standpoint.
Thank you.
Our next question is from Peter Winter with Wedbush Securities. Please go ahead.
Good morning.
Hi, good morning.
You guys mentioned the outlook for the third quarter modest loan growth in the third quarter I'm. Just wondering could you talk about the loan pipelines and overall customer sentiment right now.
And I am just I'll start off and I think others will jump in I mean, I think that I think our pipelines are are quite good when you look at.
Where where you see them in July I basically call them.
Strong and building.
And I'd say that.
Even when you look out into the third quarter on the commercial side I think we've seen nice growth into getting our stance in geographies and in our in our industry verticals.
On the consumer side of things, we like the profile of education refinance mortgage and unsecured you have to keep in mind, we do still have an auto.
Runoff.
And there is the industry dynamic of home equity runoff that.
But you've got to keep in mind, so thats, maybe more flattish, but that's commercial is looks.
Looks good as particularly on a spot basis as you get into the third quarter.
Yes, I guess.
I would.
Add to that.
I think we will we're still confident in our outlook that will hit the loan guidance for the year I think in the.
Second quarter and third quarter, we're focused really on.
Managing through the transition in rates and.
Getting deposit cost right and getting NIM right.
So weve stepped up our DSO actions and we're doing a bit more trimming of loan portfolios. During this quarter, we sold about $500 million of mortgages and on the last day of the first quarter, we sold about $200 million of corporate loans.
So those are going to affect our averages kind of in the middle part of the year, but as John said, we see the pipeline is strong and so I think we'll see a pickup particularly later in Q4 that will leave us well positioned to hit the loan growth targets, we set out for the year.
Okay, and then just within loans to ask about.
Other retail I have noticed that the growth rate has slowed and loan yields have come down quite a bit.
Yes, I mean, I think there is that theres a mix shift in that in that there is a few components of that.
Within other retail you've got a variety of things going on you've got the card.
That business in there and that card business is tied to three month LIBOR and payment long has come down. There's also some other things that.
In the unsecured space that that would.
That would affect that in our in our merchant finance merchant finance partnerships that would have an impact on that so.
Yes, I mean, I think it's more mix than anything else and I wouldn't I wouldn't say that thats.
I believe that this trend.
Sure of how some of those partnerships work.
Ken can be different based on the sharing arrangements, we have with the sponsor and so.
I can also cause different different optics.
But theres no real pressures there there is no real maybe there's a little tightening of risk appetite, but nothing.
That dramatic.
Okay. Thanks very much.
Sure.
Our next question is from Kennison with Jefferies. Please go ahead.
Hi, Thanks. Good morning, guys are talking about how the letter map came through in terms of your capital return Africa, and then your points about where the shares have been can you talk to us about any changes in your view about that.
One expected reduction in the pace of which and.
Right, you think differently in the future about Chris.
Balancing our WSE growth versus getting back more to shareholders via the buyback.
Yeah.
I'm going to start off this is John I mean, I think the pace of our glide path is still intact I mean, how do we do have.
We're on track and have an expectation of getting to our 10.2% number at this point.
And so thats back to our.
Broadly reaffirm our expectations for the year that we talked about earlier and I do think that.
So not a lot's changed on that front I mean, we still find good value in terms of.
The buyback as you heard from Bruce earlier.
Just in terms of how that.
How that works.
And that gives us significant financial flexibility to support the investments we want to make in our WSE growth as well as.
From time to time, you've seen us do some bolt on acquisitions and so that that allows us to keep all of that that does that.
That flexibility is nice to have as we get as we head into 2020, and you've also seen us be able to increase our our return in the form of dividends as we are getting that up into the 35% to 40% Arena eventually as we get near.
Our target is that will that will not that will moderate and I'll get back into dividend return and and supporting our wu way with a with a declining buyback eventually.
As you get closer to your target, but but for this year, while our trends are intact and I would just reiterate candidate as I've said in the past.
That our risk profile certainly is.
At median or better in terms of more conservative in my view. So there is no reason longer term that we need to have a capital position that.
Thats above the median in the peer group.
So you will.
Take those decisions as we go in due course, but.
Just worth pointing that out once again, so I think we have flexibility.
To keep moving lower I think it's been as John said really great to add a little bit of cushion. There that we can kind of have our taken needed to weakness good loan growth. We can do these bolt on deals we can get a very nice payback.
To shareholders and capital returns.
And so we still have a bit of room to run on the.
Got it and a follow up for just how are you thinking about continuing to remix in terms of the preferred stock, which you've been doing over the last year. It's still have some more room to go with rates, where they are we think that it's pretty advantageous to get more of that done, but just your thoughts on that would be great. Thanks.
Yes, I mean, I think that were below peers in terms of our that bucket one bucket as you know and we've been we've been filling that up a bit over time, I mean, you could see something like that in the future as something we clearly take a look at and I think it's served us well to to do it over time I mean, if we would have filled the entire bucket six months ago, we would.
We might have gotten all of that off at a level that would not be quite as favorable as something we might do.
Over.
In the near future. So so yes, I mean, you may see something like that in the future, but we keep an eye on on on that and and and look at that is similar to.
Our CET, one overall and look at that as a glide path overtime and there Ken the caliber Asus on.
Where what's our return on equity and then what's the cost of the preferred stock and so.
There are opportunities now to get that arbitrage now that we've got our early higher we couldn't do it early days during the turnaround phase, but now we have the capacity to do that and substitute preferred stock for further buybacks. So certainly something thats on the radar that we'll continue to look at it.
Okay got it thanks guys.
Our next question from John Pancari with Evercore ISI. Please go ahead.
Good morning.
Okay.
On the.
Just wanted to get a little bit more clarity on the net interest income guidance or the rig.
You reaffirmed your full year guidance. So if it now if you're now looking.
For two cuts to fed cuts by the end of the year.
But sure.
But you are reaffirming your 5% to 6.5% guidance and you look for stable quarter Eni does that imply that you could be at the low end of that 5% to 6.5% full year 19 Eni guide.
Yes, John I think you might have Miss heard what what we said.
So let me just clarify.
So we broadly reaffirm the full year guidance overall, so you so we feel that.
The guidance, we gave back in January in terms of where net income and EPS would be worse, we still feel confident that we will hit that which is good.
And then we said that the kind of there will be puts and takes to deliver that.
And so when we go through the major income statement categories would be a bit to the left side of the goalpost, but still positive on net interest income we would be to the right side of the goalposts and outperforming on fees.
We'd be to the left side of the goal posts on expenses and outperforming on expenses and we'd be near the bottom of the goal posts on credit so.
Everything lines up very well.
The good news is that we found offsets to the funny anticipated impacts from rate on NIM. So we called out that our loan volumes will likely be where they thought they would be the one kind of missing link in the equation is that NIM is going to be lower than our going in assumption when we started the year.
But we'll make up for that in other ways.
Got it all right that's helpful. Bruce and then.
Separately on the.
Efficiency outlook I know you had previously indicated a medium term.
Efficiency target of about 54% how are you feeling about that now given the backdrop. Thanks.
I still think we're going to get there. So one of the one of the advantages of this top six program, it's going to continue to help drive the efficiency ratio improvement that we need to get our returns.
Without.
A tailwind from race or even just stable rates as we actually moved to a declining in rates that might take a little longer to get there, but we're still committed to hitting those targets.
Alright, thank you.
Okay.
Our next question from Gerard Cassidy with RBC. Please go ahead.
Thank you good morning.
Hi, good morning.
John you mentioned that.
You have less exposure now from the repositioning of the balance sheet to the short end of the curves and there is more asset sensitivity tied to the longer into the curve can you share with us if the long end of the curve goes up to two and three quarters percent find this spring of next year or the end of this year, what kind of benefit would you see from that and vice versa.
When they cut rates is the is the whole shift in the yield curve comes down what what would that do to your outlook.
Yes, so I'll just maybe take it at the overall level and you can break it down short and long I mean overall in the in the instance of call. It a 25 basis point across the curve.
Decline shift down parallel shifts down you would see something in the neighborhood.
Modeled.
Call. It 60 ish million dollar impact on a full year.
Quarterly that's about 15 million. These are all modeled outcomes.
And.
You'd have to.
A lot of the outside our model things that would would would have an impact on on that but but that's about what you would see is about $15 million a quarter, which is in the neighborhood of four basis points.
But that said, we almost never see those those parallel yield.
Chips down if the shift down is is on the short end, we have a much lower exposure, which is what we're expecting rate. We're expecting short end cuts of it of one or two this year I mean, we have modeled too but in that case.
Within within that any given quarter. It's now just a couple single digit millions of net interest income exposure, which is what the impact of shifting exposure out. The curve is really done. So now we're at around 25% of that $15 million is sensitized to the short end of the curve falling.
So and it's not exactly symmetrical, but directionally symmetrical on on the on the number of things affecting that anytime soon but.
But.
That's how it works out.
And just to confirm when you are saying that 25 basis point in parallel shifts and I agree with you we really don't see that.
And when you mentioned 15 million a quarter that's down correct.
Thats down yes.
Yeah, and I think that that and as a result, I mean really what we've positioned ourselves to do here is that.
Is that in a yield curve shape that will be more upward sloping that's where we've positioned ourselves to benefit more today than we would have called it a year ago a year ago.
All of our benefit was really felt most of our benefit was focused on rates rising on the short end about 70, 70% or 75% of our sensitivity on the up was was tied to the fed raising rates and so as as we mentioned earlier in the third quarter of last year, we started to bring the overall level down and in the early part of this year, we shifted all of this and most of the sensitivity out to the long end, so that because of that.
Just kind of positioning for the end of the rising cycle and frankly, feeling like over time call. It over the next year or so or even into two years, we would expect the yield curve to EBIT and and we think that thats the appropriate way to position the balance sheet today versus where we were a year ago and just Gerard just wanted to make sure you heard that its not 15 in a quarter that the next move down.
Because of this positioning with the hedges. It was it was formally correct other than $15 million. So if we've got out ahead of it and we've said.
I think Bob some insurance for the moves to exactly and Thats, followed by third a year ago that would have been call it $12 million.
On a one move down and now it's $4 million that we've we've cut by a third our exposure to the fed.
Lowering rates, which is turned out to be a good a good way to us to sell into the second half of 2018.
Very helpful and maybe maybe Duncan answer. This one you guys touched on the new cash management Treasury management products on the commercial side I think you called that axis Optima.
Can you share with us and you are gravitating existing customers into that product can you share with us how challenging is it for you to get a new customer.
Into this type of product Treasury management, when they are already with a bank and have all the airlines.
Tied into that existing banks, so when you win a new.
The customer is an easy or is it difficult to get them in the Treasury management side.
It's difficult, but it will get easier.
So the more sophisticated customer the tougher it is a trend that transition of being cash management.
Portfolio, but as were expanding our middle market and doing doing more smaller size deal that generally comes with the banking relationship. So brand new client has a good chance that we're going to get that that is a cash business along with that that's helping expand our partner portal, which is called the excess money manager was very sub standard. So we didnt have a incredible market offering which with access optima and were as good as anybody else and and the early feedback from clients that we're migrating we've migrated about 1200 already is very very strong on the platform. It's a platform.
Which is got an underlying technology from a company called bottom line on it. So we will upgrade to the platform constantly as they upgrade their technology. So we'll stay in sync with the.
With the rest of the industry. So it works on a number of different levels and one of the things that shouldn't be lost on people is the core cash business is just part of the cash management offering. So if you look at our card business, which has been sailing over the last few years, it's growing at 2020, 5% a year. So your question George Thats, an easier sale because for a lot of companies. They don't have a card program already so it's not a technology transfer and additional.
New away to integrate their payables businesses, and we've been doing quite well on that side and thats been driving our.
Our kind of 2% to 3% growth in the overall cash management business. So we think that increases and we think optumhealth space, but it is difficult to transition a big cash management client.
Got it and the 1200 customers that youve already migrated what percentage of that of your commercial book is that.
About.
That includes business banking, so it's probably about 15% of the overall client base, yes, we're going to we're going to do for four waves between now and Thanksgiving to get everybody else in this platform. This decline.
You know Thats, a test and learn as we translate so we'll fix little bugs as we go along so its site has been very little so far but we certainly don't want to do a massive migration and have something that that comes out of the woodwork. So this has been very well tested we've been piloting it actually for six months already with some core clients and our advisory board. So we're very confident in quality offerings.
Very good color. Thank you.
Our next question from Ken Zerbe with Morgan Stanley . Please go ahead.
Hey, good morning.
I think with the transformational parts of the top program. How is what you guys are doing with cloud AI digital different from what you've already been doing on the tech side previously and also different from what other banks are also doing on the tax front.
Well I think theres.
Theres really two elements to.
Kind of the cash ecosystem.
In top six.
One is really around infrastructure.
And having the kind of the.
Debt stack ops infrastructure migrates is something Thats cloud based.
We've had some progress on that to date, but we're really going to accelerate that over the next couple of years.
The second Big element is how we design and develop applications.
And that really is migrating to an agile approach with a bunch of.
Teams that work across the business this step functions.
And technology.
To get to market faster with.
More nimble and flexible approach, we probably have 50 pause as we referred to in the trade.
Up in our agile environment today.
We're going to quadruple that over the next couple of years, so it's quite a bit but a significant change in terms of how we support and roll out new technologies.
Okay helpful. And then in terms of the balance sheet optimization program at this point I know, it's been going on for several years now given where we are in the rate cycle is the balance sheet optimization still having a meaningful or even a noticeable impact on re mixing into higher yielding.
Assets or at this point is it more just affect factor of your existing loan portfolio and the outlook for rates.
Yes, it's still a lot of this is John it's still a pretty a very big part of what we're doing here and there is a lot of room left to run in that program, whether you look at the asset side of the balance sheet or deposits.
We are not where we would expect to be in the next couple of years, we have a target balance sheet expectation, where the balance sheet optimization will continue to contribute over the medium term.
You will see on on the asset side of things across asset classes were still repositioning auto as an example in asset finance within asset classes, we continue to to rotate and recycle capital.
And get better and better at where we where we where we allocate.
You know that that scarce.
A resource of liquidity in capital. So there's a lot. There's a lot left to go down on the asset side on the on the deposit side of things. There is also a lot of exciting things happening there. When you look at DTA as a percentage of total deposits were still below peers.
And I think that that percentage doesn't fully reflect all the organic investments that have been getting made in Brad and don's areas that have started to show up actually when you look at the last year I think weve outperformed DTA across across the board in terms of percentage.
Growth and so there is a lot more or less to go there that that we think is a big part of of what we are doing as well as diversifying call. It in the commercial space in terms of their deposits sources. So.
That program is alive and well lots left to go.
And and in the current quarter, whether you look at it quarter over quarter or year over year. There is a positive contribution from the DSO, that's allowing us to that that's a tailwind that as one of the things that we count on to help us in our NIM performance as we sell into the headwinds of the rate environment.
And is it possible to quantify some of the impact any meaning if you just assumed a static balance sheet, but then you apply to the remix of where you are versus where you want to be.
Hi can you quantify the impact.
And there are any yet I think quarter over quarter. Our estimates are we're in kind of the mid single digits of positive.
Benefit in this in the second quarter of 19 compared to second quarter of 18, it's best to look at it year over year, because there's a fair bit of volatility quarter to quarter and Thats right in line with what we try to do for for for any given year is right around that call. It four or five basis points and and we did and we did get that and and that really was part of the story. It's not the entire story. That's part of the story when you look at our NIM performance this quarter being down four basis points compared with peers. I mean, you've got to you got to give some of that the credit to our BSL programs, which are which we spend.
Yes, similar amount of time on.
Compared to the top I mean, we do that on a on a very disciplined basis.
Month to month, working with our entire businesses and ended and it's continuing to pay dividends.
All right. Thank you.
And next we'll to Saul Martinez with GBM. Please go ahead.
Hey, good morning, guys.
Couple of questions on my end.
First on I, just want to make sure I understand the Eni guide for Threeq, because you highlighted.
I mean, the 2000 15 million a quarter on a 25 basis point cut with only 25% being at the short end so its 4 million.
Assuming a July Kai you're only getting too much into that which so the impact seemingly of late July cut is pretty negligible on eni.
If thats the case why why are we assuming.
And I stable not growing is it the long end of the curve on average is going to be lower it just it seems like.
This rate cuts really not going to impact three q. I would I would think you would actually see III growth if that were the case.
Yes, there's a couple of things that are going on you've got to certainly the impact of of LIBOR.
Is built into all of this but you've got a 20, we've got an expectation of LIBOR being down around 25 basis points or so but I mean, you've got these modeled results just two things to keep in mind and you've got the deposit lag that continues to have an impact and as I mentioned earlier.
Yes, the first cut that occurs.
In easing cycle, we will have a lower deposit beta than let's say the next cut and the numbers I was quoting to you earlier, our averages over a year. So in the first quarter of any kind of of any.
Reversal of direction on rates, you will have a lower benefit on deposit betas coming down then you'll have eventually after the full effects of that cut for in in future quarters. So thats really the main issue is really how that deposit lag flows and I'd say that you also have to keep in mind, our front book backlog, which has been a tailwind for us and remains a tailwind, but the magnitude and strength of that tailwind has has come down a fair bit.
Based upon where rates are and so when you look at long rates being down 20 530 basis points.
In the quarter and continuing to the full impact of that has to be offset as well. So I think three Q3 quarter could be seen as maybe a transitional quarter as we get through.
What's going on with that first cut which immediately impacts us on the asset side is 100% beta on all our floating assets that happens right out of the gate, but the deposit beta deposit betas are less than that and deposit lag in front book back book and all of that tends to tends to re stabilize itself as you get into the fourth quarter.
Thats helpful and on that latter point on the ACIP beta coated week, you obviously youve.
Youve.
Increased your fixed.
Ray receive positions.
Over the last year, and you've got balance sheet optimization.
How do we think about loan yield betas commercial loan yield betas.
Retail loan yield betas with a 25 basis point cut because even this quarter I think you actually seen a basis point of yield expansion on commercial even with LIBOR coming in.
How much of that actually goes through given all the mixing the hedging.
How much of that actually goes we'll go through.
And to your loan yields.
Yes, maybe just top of the house you it'd be good to talk about the fact that we are generally 50 50 in the loan portfolio. After you consider swaps were generally 50% floating 50% fixed and that was true in the first quarter, but after continuing our program of adding received fixed swaps were a little lower on that front. So you.
You could basically say that our loan portfolio was down from 50% floating post swaps to 40% to 45% or so post swap. So therefore, our back to the point that we're we're indicating our overall asset sensitivity is falling in part due to the fact that our loan betas will likely be a little lower as the margin due to the hedging that we've done and and also due to the even more importantly, all the hedging impacts by shifting all of it out the curve. So we've been positioning and all of that will flow through in loans and deposits weve been positioning for exactly this kind of environment, where the long end up is that more likely expectation of the tailwind that overtime over the next several years than than counting on the short end to be up meaningfully and I think we're we're really pleased with how we position that.
So hopefully that helps yes, im sorry, just one for you said, 40% to 45% loan or interest, earning asset is floating 40, 545% of the entire loan portfolio is 'cause can be sitters floating post fee impact of swaps got it. Okay. Thats helpful. Thank you first is versus 50% last quarter and it was a little higher the quarter before because weve been adding to a year ago, because weve been adding CJ swaps over over the last three quarters.
Okay, all right no thats clear thank you.
Thanks.
And our next question is from Lana Chan with BMO capital markets. Please go ahead.
Hi, Good morning, and just wanted to follow up on that last point. The swaps could you give us any details around 14 billion of swaps at terms that make sense.
If any is can select starting.
Yes.
None of them are forward, starting I mean the rate. The terms are basically I receive fixed swap position is is on a gross basis is around 20 billion reais and I kept saying that is because thats offset by about five or $6 billion of pay fixed swaps that we executed.
That are important to know thats, how we shifted our sensitivity out the curve as we executed some pay fixed swaps at around 170, or so at the five year, Mark which caused.
Which basically indicated that our sensitivity is now out the curve the gross.
$20 billion on received.
Our basically in the neighborhood of two years of remaining maturities and thats basically protecting against potential using cycle over the next call. It two years, which is where there's received fixed swaps for cash and then and then releasing that sensitivity I should get out farther and over the medium term where were there.
Where we think that.
More than likely that that will will cover any any easing cycle that might that might flow through.
Okay and sorry, the average received rate is like on those slots.
It's probably closer to 2% system like color, 185% to 2% range and we've been dollar cost averaging and over the last three quarters. So.
Surrounding that.
Okay. Thanks, John .
Right.
And with no further.
Yes, all the questions yes.
Ill turn it over to you Mr. van Saun for closing remarks.
Okay.
Well, thanks again, everyone for dialing in today, we appreciate your interest and your support have a great day.
Ladies and gentlemen that concludes today's conference call. Thank you for your participation you may now disconnect.
Uh huh.