Citizens Financial Group Inc (CFG) — Q4 2022 Earnings Call Transcript

Thank you, Keeley. Good morning, everyone, and thank you for joining us. First, this morning, our Chairman and CEO, Bruce Van Saun; and CFO, John Woods, will provide an overview of our fourth quarter and full-year results. Brendan Coughlin, Head of Consumer Banking; and Don McCree, Head of Commercial Banking, are also here to provide additional color. We will be referencing our fourth quarter and full-year 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 are also referencing non-GAAP financial measures. So it's important to review our GAAP results on page three of the presentation and the reconciliations in the appendix. With that, I will hand over to you, Bruce.

Okay. Thanks, Kristin. And good morning, everyone. Thanks for joining our call today. We're pleased with the financial performance we delivered for the fourth quarter and the full year, and we feel well positioned to navigate through an uncertain environment in 2023. We are playing strong defense with a robust balance sheet position and highly prudent credit risk appetite. At the same time, we continue to play disciplined offense with continuing investments in our growth initiatives. We are focused on building out a prudent, sustainable growth trajectory over the medium term. I'll comment briefly on the financial headlines and let John take you through the details. For the quarter, our underlying EPS was $1.32, our return on tangible common equity was 19.4%, and the efficiency ratio was 54%. Sequential operating leverage was 1%, and sequential PPNR growth was 2.6%. Leading our performance was 2% sequential NII growth, reflecting NIM expansion of 5 basis points to 3.3% and relatively stable loans given the impact of a $900 million reduction in our auto portfolio. Growth was 1% ex this impact. Deposits were solid with 1% sequential growth, and our LDR remained stable at 87%. Our fee businesses showed resilience and diversity, given a challenging environment, down about 1% sequentially. A number of M&A fees pushed into Q1, and mortgage results were softer than expected. We maintained stable expenses in the quarter, and credit metrics remain good. We boosted our allowance for credit losses to 1.43% of loans, which compares with pro forma day 1 CECL levels of 1.30%. We restarted our share repurchase activity in Q4, buying $150 million of stock, and we ended the year with a CET1 ratio of 10% at the top of our targeted range. For full-year 2022, we delivered underlying EPS of $4.84 and ROTCE of 16.4% as we captured the benefit of rising rates and our strengthened deposit base. The results handily exceeded our beginning-of-year guide, which we included in the appendix of the presentation. With respect to our guidance for 2023, we assume a slowdown in economic growth to 1% for the year, two early Fed rate hikes, and a Q4 cut, and inflation getting below 3% by Q4. We project moderate loan growth, partially offset by continued runoff in our auto book of close to $3 billion. Overall, we see solid NII growth as NIM gradually rises to 3.4% over the year, a roughly 8% growth in fees to kind of rebound in capital markets fees over the course of the year, solid expense discipline with core expense growth ex-acquisition and FDIC impacts of 3.5% to 4%. We announced today our TOP 8 program, which targets $100 million in run rate benefits, and about 80% of that is expense impact. Credit should be manageable with net charge-offs in the 30 to 35 basis point range, and we expect to build our ACL to 1.45% to 1.5% of loans. We expect to repurchase a meaningful amount of stock, given strong profitability, modest loan growth, and limited expectations for acquisitions with our CET1 ratio forecast near the high end of our 9.5% to 10% range. Capital return to shareholders should approach 100%, yielding investors of our dividends plus capital return via repurchase 12%. So, all in all, a very strong year of execution and delivery for all stakeholders by Citizens in 2022, and we feel we are well positioned in 2023 to continue our journey towards becoming a top-performing bank. We continue to make good progress in executing on our strategic initiatives across consumer, commercial, and the enterprise. We've transformed our deposit base and are reaping the benefits. We've adjusted our interest hedging to protect against lower rates through 2025. Given the improvement in our ROTCE over time, we are raising our medium-term target to 16% to 18% from 14% to 16%. We've stayed focused on positive operating leverage. We've captured the benefit of moving to a more normal rate environment, and we still have plenty of upside in our fee businesses as market conditions improve. Exciting times for Citizens. I'd like to end my remarks by thanking our colleagues for rising to the occasion and delivering a great effort in 2022. We know we can count on you again in the new year. And with that, I'll turn it over to John.

Thanks, Bruce, and good morning, everyone. Big picture, 2022 was a strong year for Citizens with significant delivery of strategic initiatives against the backdrop of uncertainty and volatility in the macro environment. Most notably, we closed our acquisitions of HSBC and ISBC. We captured the benefit of higher rates with strong NII and NIM, and our balance sheet and interest rate position were well managed. While fee revenues were impacted by the environment, we are very well positioned across our businesses to capitalize on the upside potential when markets normalize, particularly in capital markets. Mortgage margins and volumes should recover over time, and we are excited for the growth prospects arising from our wealth investments. We are actively managing our loan portfolio, focusing on allocating capital where we can drive deeper relationship business into 2023 and beyond. We continue to maintain good expense discipline, delivering in excess of $115 million of pre-tax run rate benefits through TOP 7, generating 4.7% underlying positive operating leverage for the year and 16.4% full-year ROTCE. Let me give you the headlines for the financial results, referencing slide five. For the fourth quarter, we reported underlying net income of $685 million and EPS of $1.32. Our underlying ROTCE for the quarter was 19.4%. Net interest income was up 2% linked quarter with 5 basis points of margin expansion to 3.3% and relatively stable loans, given a planned reduction in our auto portfolio. Period ended average loans are broadly stable linked quarter, up 1%, excluding auto runoff. We grew deposits up 1% linked quarter, and our LDR was stable at 87%. Fees showed some resilience in a challenging environment, down 1% linked quarter. We saw a modest improvement in capital markets fees driven by underwriting and M&A, but this was more than offset by a drop in mortgage fees and a CDA DDA impact in our FX and IRP business. Expenses were broadly stable linked quarter. Overall, we delivered underlying positive operating leverage of 1% linked quarter, and our underlying efficiency ratio improved to 54.4%. Our credit metrics were good, with NCOs of 22 basis points, up 3 basis points linked quarter. We recorded a provision for credit losses of $132 million and a reserve build of $44 million this quarter. Our ACL ratio stands at 1.43%, up from 1.41% at the end of the third quarter and approximately 13 basis points above our pro forma day 1 CECL adoption coverage ratio. Our tangible book value per share is up 5% linked quarter. Next, I'll provide further details related to the fourth quarter results. On slide six, net interest income was up 2% given higher net interest margin. The net interest margin of 3.3% was up 5 basis points. As you can see on the NIM walk on the bottom left-hand side of the slide, a healthy increase in asset yields continues to outpace funding costs, reflecting the asset sensitivity of our balance sheet. With Fed funds increasing 425 basis points since the end of 2021, our cumulative interest-bearing deposit beta has been well controlled at 29% through the end of the fourth quarter. Moving on to slide seven. We posted solid fee results despite headwinds from continued market volatility and higher rates. These were fairly stable, down 1% linked quarter with lower mortgage and FX and derivatives fees, partly offset by an improvement in capital markets fees. Focusing on capital markets. Market volatility continued through the quarter. However, underwriting and M&A advisory fees picked up. We continue to see good strength in our M&A pipeline, including several deals that were pushed into Q1. Mortgage fees were softer as the higher rate environment continued to weigh on production volumes. We have seen pressure on volumes moderating and the size of the industry reducing capacity, which should benefit margins over time. Servicing operating fees were stable. Card and wealth fees posted solid results for the quarter. On slide eight, expenses were well controlled, broadly stable linked quarter. Our TOP 7 efficiency program delivered over $115 million of pre-tax run rate benefits by the end of the year. We are excited to announce the launch of our new TOP 8 program, and I'll cover that in a few slides. On slide nine, average and period-end loans were broadly stable linked quarter but up 1% ex auto runoff with 1% growth in commercial, reflecting demand in asset-backed financing and growth in CRE, primarily reflecting line draws and slower paydowns. We have seen commercial utilization moderate a bit over the quarter as inflation and supply chain pressures continue easing and clients are adjusting inventories to reflect this as well as lower CapEx in anticipation of a softer economy. Average retail loans are down slightly, but up 1% ex planned runoff in auto, given growth in mortgage and home equity, which bring an opportunity for deeper relationships and better risk-adjusted returns. On slide 10, average deposits were up $1.4 billion or 1% linked quarter, with growth primarily coming from term deposits, money market accounts, and Citizens Access Savings. Overall, commercial banking deposits were up 2.4%, and consumer banking deposits were broadly stable. We feel good about how we are optimizing deposit costs in this rate environment. Our interest-bearing deposit costs were up 67 basis points, which translates to a 29% cumulative beta, broadly consistent with our expectations. We began the rate cycle with a strong liquidity and funding profile including significant improvements through our deposit mix and capabilities. We achieved overall deposit growth this quarter, and we will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits. Overall liquidity remains strong as we reduced our FHLB advances by $1.3 billion and increased our cash position at quarter end. Our period-end LDR improved slightly to 86.7%. Moving on to slide 11. We saw good credit results again this quarter across the retail and commercial portfolios. Net charge-offs were 22 basis points, up 3 basis points linked quarter, which is still low relative to historical levels. Nonperforming loans are 60 basis points of total loans, up 5 basis points from the third quarter, given an increase in commercial, largely in CRE. Retail delinquencies continue to remain favorable to historical levels but we continue to closely monitor leading indicators to gauge how the consumers vary. Although personal disposable income remains strong, debt service as a percentage of disposable income has essentially returned to pre-pandemic levels while consumer confidence has stabilized as inflation has eased. Turning to slide 12, I'll walk through the drivers of the allowance this quarter. While our current credit metrics are good, we increased our allowance by $44 million to take into account the growing risk of an economic slowdown. Our overall coverage ratio stands at 1.43%, which is a modest increase from the third quarter. The current reserve level contemplates a moderate recession and incorporates expectations of lower asset prices and the risk of added stress on certain portfolios, including those subject to higher risk from inflation, supply chain issues, higher interest rates, and return-to-office trends. Given these pressures, we are watching our loan portfolio very carefully for early signs of stress, in particular, CRE office. Back on slide 32 in the appendix, we have provided some additional information about the CRE portfolio. Our total CRE allowance coverage of 1.86% includes elevated coverage for the office portfolio while the multifamily portfolio has a much lower reserve requirement. The $6.3 billion office portfolio includes $2.2 billion of credit tenant and life sciences properties, which are not as exposed to adverse back-to-office trends. The remaining $4 billion relates to the general office segment for which we are holding roughly 5% allowance coverage. About 95% of the general office portfolio is income producing and about 70% is located in suburban areas. Moving to slide 13. We maintained excellent balance sheet strength. Our CET1 ratio increased to 10%, which is at the top end of our range. Tangible book value per share was up 5% in the quarter, and the tangible common equity ratio improved to 6.3%. We returned a total of $350 million to shareholders through share repurchases and dividends. Our strong capital position, combined with our earnings outlook, puts us in a position to continue to return capital to shareholders through additional share repurchases. Shifting gears a bit. Starting on slide 14, we'll cover some of the unique opportunities we have to drive outperformance over the next few years. We have tried to be very disciplined in prioritizing the areas that we think have big potential and where we have a right to win. So, in Consumer, we've got four big opportunities. First is our push into New York Metro. We are investing in brand marketing, doing well in the technology conversions, and putting our best people against the market opportunity. We are encouraged by our early success with some recent client wins in commercial and the HSBC branches driving some of the highest customer acquisition and sales rates in our network. The full ISBC conversion is just around the corner on President's weekend, and we look forward to making further strides as we leverage the full power of our product lineup and customer-focused retail and small business model across the New York market. You will see more details on slide 28 and 29 in the appendix. Importantly, we achieved about 70% in run rate of our planned $130 million of investors' net expense synergies as of the end of the year and we expect to capture the rest by the middle of the year. We also continue to expect that the integration costs will come in below our initial estimates. Moving to wealth. We've launched a number of exciting initiatives with Citizens Private Client and CitizensPlus as we orient the business towards financial planning-led advice. These should really help us penetrate the opportunity with our existing customer base. On slide 15, our national expansion is another area where we have a great opportunity to build on our digital platform that has been focused on deposits for the last few years. We've moved that to a cloud-based platform, and we are adding our other product capabilities so that we can offer a complete digital bank experience to serve customers nationwide with a focus on the young mass affluent market segment. Where we might have only had a lending or deposit relationship before, our vision is to build a national platform that allows us to serve our customers in a comprehensive way. And we have also been very innovative in creating distinctive ways to serve customers. Citizens Pay, for example, is an area where we have significant running room. We've attracted many new partners, up about 150 versus a year ago, which should really ramp the business. And we built an industry-leading home equity business, powered by our innovative fast line process, which is enabled by advanced analytics and digital innovations that have drastically reduced originations time. Moving to the Commercial Bank on slides 16 and 17, we have addressed all product gaps. Our acquisitions have enhanced our M&A and advisory services, and we have developed our debt capital market capabilities organically. We've recruited top coverage bankers and are concentrating on high-growth areas across the nation as well as the right industry sectors to cater to larger companies. Our sponsor coverage is strong, positioning us well to support private equity capital. In summary, we have positioned ourselves with attractive opportunities and a comprehensive product set to significantly increase market share and generate fee revenues. On slide 18, we're excited to announce the launch of our latest TOP program. As we press forward with our strategic initiatives and acquisitions, it's essential to recognize that Citizens' success since our IPO has stemmed from our ongoing efforts to discover new revenue streams and enhance efficiencies while reinvesting those gains back into our business to better serve our customers. We've successfully implemented our TOP 7 program, achieving a pre-tax run rate benefit of around $115 million by the end of 2022. Additionally, we've initiated TOP 8, aiming for a pre-tax run rate benefit of about $100 million by the end of 2023, with approximately 80% of that stemming from efficiency-oriented initiatives and 20% from revenue-focused efforts. Moving to slide 19, I'll discuss the full year outlook, anticipating an economic slowdown with a view of two 25 basis point Fed hikes before an expected 25 basis point cut in the fourth quarter. We anticipate solid net interest income growth of 11% to 14%, with our net interest margin gradually rising to around 3.4% by the fourth quarter of 2023. Our overall hedge position is projected to sustain a net interest margin floor of about 3.2% through the fourth quarter of 2024, along with a gradual 200 basis point decline across the curve starting in Q4 2023. In the fourth quarter, we have transitioned $3 billion of active swaps to forward-starting positions in 2024 and have made further adjustments in January to rebalance our down rate protection. A summary of our hedge position is found in the appendix on slide 30. We expect moderate loan growth, with average loans increasing by 4% to 5%. We are targeting roughly $3 billion in spot auto runoff as we realign the portfolio toward products offering more attractive risk-adjusted returns. Total average earning assets are expected to rise by 3% to 4%. On the deposit front, we anticipate a 3% average deposit growth and a 2% to 3% decline in spot deposits, with cumulative deposit betas at year-end reaching the high 30s. Total expected growth is 7% to 9%, fueled by a capital markets recovery throughout the year. Noninterest expenses are projected to rise by around 7% or approximately 3.5% to 4% when adjusting for the full-year impact of the HSBC and investor acquisitions as well as the FDIC premium increase. If the year unfolds as we foresee, we expect to achieve around 400 to 500 basis points of positive operating leverage. Given current macro trends and portfolio originations, we anticipate our allowance for credit losses ratio to increase to the 1.45% to 1.5% range, depending on economic conditions. We expect our common equity tier 1 ratio to position itself at the upper end of our target range of 9.5% to 10%, even with our target payout ratio nearing 100%. This all translates to a return on tangible common equity in the high teens for 2023. On slide 20, we provide guidance for Q1. Note that Q1 tends to be seasonally weak for us due to the impact of day count and seasonal trends on revenues, along with tax implications on compensation payouts affecting expenses. Moving to slide 21, as Bruce mentioned, we have fully transformed the franchise since the IPO, effectively executing our priorities and achieving our performance targets, setting us up to increase our ROTCE target from 16% to 18%. The key to further ROTCE improvement lies in continuing to deliver positive operating leverage. Looking ahead to the medium term, we expect a recovery in loan and deposit growth while we continue optimizing our balance sheet to focus on deep relationship lending for maximum risk-adjusted returns. We are well positioned to meaningfully increase our fee income. Even if interest rates decline slightly, we expect net interest income to benefit from the protections we've established through the swap portfolio. We will maintain discipline regarding expenses. Credit is forecasted to remain stable as the economy strengthens, and we intend to return a substantial amount of capital to our shareholders through our repurchase program while targeting a dividend payout of 35% to 40%. Over this period, we aim for our common equity tier 1 ratio to stay within the target range of 9.5% to 10%. In summary, on slide 22, we've had a strong quarter amid a dynamic environment and maintain a positive outlook for 2023. We are prepared for the uncertainties posed by an economic slowdown in 2023, boasting a robust capital, liquidity, and funding position. We've acted to protect our net interest margin while being cautious regarding credit risk and loan growth. At the same time, we are advancing our strategy and making significant investments in our business that we believe will yield sustainable growth and outperformance in the medium term. With that, I'll turn it back to Bruce.

Okay. Thank you, John. And operator, why don't we open it up for Q&A?

It sounds like you guys rebalanced some of the hedges in the fourth quarter and are continuing to do so year-to-date. I was hoping you might please just expand upon how you're thinking on how those changed since last quarter and sort of how you intend to position yourself?

Yes, I'll start. Looking at the broader picture, our asset sensitivity last quarter was around 3%. This quarter, we're slightly below that due to the anticipated outlook for the balance sheet in 2023. Over time, we've reduced our asset sensitivity, primarily influenced by the short end of the curve, which we expect to stay elevated throughout 2023. As a result, we are repositioning some of the down rate protection we had in place for 2023, moving from spot-starting active swaps to forward-starting swaps for 2024 and beyond. Our goal is to extend that down rate protection into 2024 and 2025 instead of retaining all of it in 2023. That was our main focus in the fourth quarter, and we've continued that approach into early 2024. Additionally, we are aiming to protect our net interest margin corridor. If rates were to decline by 200 basis points in 2024, we anticipate a floor of around 320, establishing a corridor of 320 to 340, which is narrower than what we've shown in past cycles. This is our primary objective.

And I would just add to that, Scott, in our view in the macro is that the Fed likely moves maybe most or twice the forward curve as they'll move up 25 basis points a couple of times and then stop. And then typically, they would pause for six or seven months before they would cut. And so if there's a cut happening, it likely happens very late in the year and maybe it could be early next year. So guided by that view, that's kind of why we're pushing out that downside protection a bit.

Terrific. And then just a separate question. It looks like fees will need to rebound fairly meaningfully following the first quarter to hit the guide? I know, Bruce, you had mentioned an expectation for improved capital markets through the year. Maybe just a thought or two on how you see the main drivers of that fee guide as the year progresses, please?

Sure. You're right to point out the capital markets business. We have had strong pipelines this year, but the volatility and the Fed continuing to raise rates has caused uncertainty and made it difficult for private equity to get funds to work and complete deals due to lack of available financing compared to previous years. As the Fed approaches its peak rate, I believe this will loosen up the financing markets, reduce volatility, and allow the business that's currently in our pipeline to start progressing and result in more transactions. For reference, our capital markets revenues this year have ranged from $90 million to $100 million per quarter, whereas in the fourth quarter of 2021, we generated $184 million in fees, roughly double that amount. We expected to see stronger revenue generation this year, but the positive aspect is that we remain focused on the right market sectors and have a great team, which should help as market conditions improve. I'm also optimistic about our investments in the wealth business. If we see stability in the asset markets, that should provide a boost along with our investments. In the mortgage sector, it seems to have bottomed out, and while it did decline further in the fourth quarter, I anticipate that as people exit the business, we will see margins increase and volumes grow throughout the year, especially as the Fed stabilizes rates. Those are the key points I wanted to share. I’ll pass it on to Don for any additional comments.

Yes. I think you've pretty much covered it on cap markets. I said this last quarter, I'll just remind people, again, we are a middle market investment bank. So we're not dependent on these giant transactions that need $5 billion of financing. We do singles and doubles all day long, and our pipelines are reasonably strong with a very heavy content of private equity who is a watch with cash. So, there will be transactions. If you don't get regular way transactions, you're going to get a lot of restructuring transactions. So, there's minority capital. There's a lot of different ways to skin the cat. So, we're relatively optimistic about what's ahead of us in the coming year.

Yes. Brandon, anything…?

I think you expressed that very well. For the year, we are anticipating slow and steady progress, and there is a sense of hope that the equity markets will rebound significantly. As long as they remain stable, we should experience some growth. Another positive aspect is that debt and ATM fees continue to reach record levels due to customer engagement and loyalty, along with the investments we've made in strengthening our franchise. This is also improving our deposit quality, along with some restructuring of vendor relationships that is providing an additional lift. We expect this area to show consistent, gradual progress. However, there will still be some pressure on overdraft income and service charges, but we're approaching a point where that's mostly accounted for, indicating that we are nearing the bottom. This is a positive sign that it will soon cease to be a challenge for us.

I wanted to ask on credit. John, you mentioned that most of the increase in nonperforming loans was commercial real estate. I was just wondering, was that office related? And if you can just give a little bit more color on what your outlook is for office?

Certainly. I'll discuss the coverage levels. Generally, as noted in our materials, the CRE coverage from an allowance perspective is around 186 basis points. However, if we exclude some of the high-quality segments like multifamily, credit tenant lease, and life sciences, we see our general office segment showing robust coverage of about 5%. There are trends suggesting that we should set aside some reserves to address the challenges posed by the return-to-office dynamics in that area. While we have a healthy coverage of approximately 5%, we are observing some shifts into the nonaccrual category. Overall, our pre-LTVs are typically around 60%, so it's important to differentiate between non-accruals and actual loss content. Although we are allocating some allowance, we believe it appropriately reflects the loss content we are witnessing in our portfolio. I'll pause there.

Hey, Don, do you want to add?

I'll just say for the office portfolio, but CRE in general, it's first and foremost, who's the sponsor and who's the investor, and we have a very high-quality group of investors that we do business with, which are largely institutional. Second is what MSAs are you in and where are you? And we think suburban will do better than urban. As we said in the comments, we're heavily weighted to suburban. So, we're going through every single property in the office portfolio. We'll restructure a lot of them with the sponsors. We restructured one already this year where the sponsor-contributed equity. So, we're comfortable around where we are with the coverage ratios right now, but we'll be active in restructuring the portfolio. But we kind of like the contours of what we've got.

Got it. And then just as a follow-up, can you just talk about what changed in the updated margin guidance of towards 3.40 versus the prior guidance of 3.50? Is it just the higher deposit beta outlook?

I will address that. Broadly speaking, there are two main points to consider. Firstly, the rapid pace of rate changes and their effects on our expected deposit mix migration into 2023 are the primary focus for us. This migration is evident in two ways: the volume of DDA migration we are observing and the cost of our lower-cost deposits, which we see both on our platform and across the industry. In terms of trends from the fourth quarter and the outlook for rates moving forward in 2023, it’s important to note the transformation of our deposit platform. Before the pandemic, DDA percentages were in the low 20s, while currently, in the fourth quarter, 28% of our deposit franchise is in DDA. This marks a significant increase since before the pandemic. We anticipate that we will close the year with DDA figures in the mid- to high 20s, slightly below current levels, yet still of high quality. Including consumer CRE and consumer savings, we have around 15% or more of our deposit portfolio in low-cost categories, a rise from the low 40s prior to the pandemic. This represents a multi-year transformation of our deposit franchise. Thus, as we look ahead to 2023, we are calibrating our expectations based on the majority of the decline from 3.50 to 3.40. Additionally, the quickly rising rates impact how long front-book originations take to contribute. Lastly, while the rapid rise in rates and the inversion of the yield curve present headwinds, front-book, back-book remains a positive tailwind over time. We’re seeing a 300 basis point positive front-book, back-book across our securities and fixed-rate lending businesses, which will continue to support net interest margins in 2023, though not as significantly as we previously anticipated.

Wondering, Bruce, heard your earlier comments about we're at 1.30 ACL day 1 adjusted for the deals in the low 1.40s now and your comments about 1.45, 1.50 year-end. I'm just wondering if you can help us, given that you're slowing loan growth and letting the auto book run out, how do you just help us understand what you're seeing in terms of what your CECL impact might be looking ahead versus the impact of slower loan growth in terms of that endpoint that you're expecting?

Sure. I'll start. John can take over after me. What we've been doing over the past few quarters is continuously assessing the macroeconomic forecast and identifying any segments of our portfolio that might face challenges due to the Fed's ongoing rate increases and the downgraded economic growth projections. I read today that over 60% of leading economists are providing their forecasts for this year. This gradual buildup we've been undertaking is a response to that situation. At some point in 2023, we expect to have more clarity and less uncertainty. However, we don't see that happening just yet. Therefore, it seems sensible to expect that the allowance for credit losses will increase by a few basis points each quarter, leading us to a range of 1.45 to 1.50. Eventually, we will see the recessionary impacts, and then we can reevaluate based on our charge-off experiences and possibly release some of those reserves. Additionally, Ken, the slower loan growth somewhat alleviates the extent of the buildup, but those are the dynamics at play. John, do you want to add anything?

Yes, I'll add that for the last couple of quarters, we have factored a mild-to-moderate recession into our models. Our projected peak-to-trough GDP decline is 1.5%, which indicates a moderate recession. The changes observed in the second half of 2022 were influenced more by the outlook on collateral values than by recession expectations. In terms of house and used car prices, we have increased the anticipated declines. Our models now account for low to mid-teens declines for both house and auto prices in the foreseeable future. This is not leading to a significant increase in losses, as we have been experiencing substantial recoveries in the portfolio over the past year. However, lower recoveries may be seen, which will affect our loss forecast for 2023. This is an important aspect of our outlook for 2023 and 2024.

Got it. Okay. And just one quick follow-up on the capital point. You're nearing 100% implies a nice incremental step up in the buyback. I'm just wondering how you're thinking about the mix of the dividend versus the buyback going forward, yet you obviously moved to $0.42 in the third quarter. Should we also think about that you would be moving the dividend up in line with increased earnings potential as well within that context?

Yes. I'd say what we do here is every year, we're on a cadence where post-CCAR, we basically take that as the opportunity to broadly update our capital return profile. Over the medium term, we're looking at 35% to 40% dividend payout. And you saw that in some of our medium-term outlook. We've updated that this is going to be more of a buyback return year in '23 because of the outlook for RWAs. But we take a look at a dividend policy and earnings outlook and update whether there should be a change in the dividend after CCAR.

Yes. And I would just add to that, Ken, that clearly, with the uncertainty in the environment, we are being cautious in terms of the lending of kind of risk appetite. And so, I think that, in and of itself, creates some additional capital versus what we've had in prior years. I also think we still have our plate full integration of existing acquisitions, and we haven't seen a whole lot that's attractive at valuations that we're interested in on the acquisition front. And so I think the combination of operating at very high profitability levels with ROTCE returns in the high teens plus more modest loan growth than historical, more modest acquisition activity than historical creates the opportunity. And I think it's appropriate given the uncertainty and chance for recession that returning capital to shareholders is the right course of action here. So you could expect we would like to raise the dividend during the course of the year, and we'd also like to get close to that 100% return of capital to shareholders.

On the overall deposit dynamics, I know you expect a 2% to 3% year-over-year spot decline. Can you maybe give us a little more color on how you expect overall deposit trends to progress through 2023 to get to that 2% to 3% spot decline? Maybe help us with the magnitude of declines that you think is reasonable here in the coming quarters as you look at deposit flows?

Yes, sure. I'll jump in there. I mean I think...

You can just start and then maybe pass it to Don and have Brendan.

Sure. Overall, as I mentioned before, we're seeing a shift in deposits both from a DDA perspective and from some of our lower-cost levels. However, the mix is better and has improved compared to pre-pandemic levels. I think we ended 4Q with about 28% DDA, and that might decrease slightly to around 27% by year-end. Some of the higher-cost deposits in money markets and savings will also decline, leading to an expected overall decline of about 2% to 3% from the end of 2022 into 2023. So, while there will be an improved mix compared to pre-pandemic, we anticipate some softening throughout 2023.

I would add that we did not attract as much surge deposit as many of our peers. Our deposit base is more consumer-oriented, which tends to be more stable. We have been closely monitoring the surge deposits, and we have found them to be stickier than we initially anticipated. The slight runoff we might see is more on the commercial side, where treasurers have other options for moving funds. However, we are relatively protected because we did not bring in a significant amount of that money from surge deposits. Don or Brendan, do you have any comments on this?

Our spot is down slightly, under 2% year-over-year. We ended this year a bit higher than expected due to favorable inflows at the year's close. As John mentioned, we've significantly transformed our deposit base thanks to our treasury services business. We now offer two specialty deposit products related to ESG, green deposits, and carbon offsets. The strengthening of our DDA deposits through our treasury services provides more stability than in previous years, and we feel optimistic about that outlook. Generally, we are managing the balance sheet carefully and avoiding new transactions due to caution in the credit environment. We are also moving clients who are not generating positive returns off our franchise and balance sheet. This approach allows us to be less aggressive in chasing deposits, as we are keeping the loan growth relatively modest.

Yes. Without being too redundant to what John mentioned, I'd say consumer has been broadly stable on deposits, which is a really good thing. And the story for us is going to be controlling the mix, but all indications are quite positive. We look at a lot of benchmarking data, and we're pretty confident that we're performing in the top quartile of our peer banks in terms of retention of low-cost deposits as well as interest-bearing deposit costs so far in the cycle. It's sort of midway through the cycle. So we've got to stay disciplined and manage it well, but it's been driven by a lot of health improvements, household growth, improvements in primacy, mix shift to Bruce's point, we were 45% mass affluent and above five years ago, we're now 60% of our customer base is mass affluent and above. So, the quality has been quite good. On the stimulus front, what we're seeing is the bottom two deciles of our customer base is essentially at the paycheck to paycheck. So that stimulus has already burned off and is in the rearview mirror. So the stimulus that remains with us tends to be with the more affluent customers, whether that's actual stimulus check. So that's balance parking that happened during COVID for not making mortgage payments and not traveling, et cetera, et cetera. We're not actually seeing that burn off as much as we're starting to see that rotate out of low-cost deposits into interest-bearing, which is natural given the stated interest rate. So, we're managing that really tight. All the investments we've made in the franchise, whether analytics, new products, the introduction of CitizensPlus in our Private Client Group as well as having Citizens Access to fence off interest-bearing deposits to maintain discipline in the core have all been really big levers for us to manage well. And all indications we see so far is that we're right on track with where we wanted to be and dramatically outperforming where we were last time and up rate cycle and at worst, in line with peers, but some signs that we may be doing a bit better, which is a big turnaround from where we were five, six years ago.

Okay. Great. That's helpful. And then separately on the commercial real estate front, I know you stated 60% LTV on overall commercial real estate. Is that origination? And then do you happen to have refreshed LTV? I know you mentioned that a lot of your deals have sponsor participation, but we're hearing that with sponsors exiting or refinancing out certain deals that's impacting the LTV, so the refreshed LTVs may be a better read, particularly on the office front.

Yes. The 60% figure refers to the office loan-to-value ratios, not the overall commercial real estate portfolio. We believe those ratios are still relatively healthy. We are in the process of refreshing the properties individually. We haven't completed a full update of the entire portfolio yet, but we are addressing the quarter-by-quarter maturities and collaborating with the sponsors to refinance, inject equity, or adjust the portfolio's value. This approach is what led to the non-performing loans this quarter, stemming primarily from one real estate deal.

This is Megan Stein on behalf of Matt O'Connor. On capital, so the 9.5% to 10% medium-term CET1 target range, that's well above the regulatory minimum. You've built reserves a lot, and it seems like the conversion time line of ISBC is going really well. So I guess my question is, I hold so much capital down the road given solid reserves and successful deal integration time line?

Yes, I would say part of it is just the philosophy of wanting to maintain a strong balance sheet. I believe a ratio of 9.5% to 10% is robust. Historically, we had aimed for a target of 10% to 10.5%, but we've been gradually lowering that as our profitability has increased. I think our stakeholders are gaining more confidence in our strategy and execution, so it wouldn't surprise me if we eventually start to manage it down within that range. Given the current climate in 2023 and the potential for a recession, it makes sense to stay at the higher end of that range for now. Once we move past that, we might consider adjusting it closer to the lower end, which could offer us more flexibility. At that point, we can reassess whether we still need a target of 9.5% to 10% or if we can reduce it a bit. For now, given the circumstances of 2023, it seems prudent to keep our target range as it is.

Yes. I'll go ahead and cover that. I mean I think when you look out into 2023, we still see very, very strong opportunities in the commercial space and within C&I. And I think something to always keep in mind is our utilization is well below where historical levels would imply we should be. And so as you get into the later part of the year, you see some recovery in investments, in inventories, and CapEx and possibly M&A, which actually provides financing opportunities. We see lots of opportunities across commercial. And that's really one of the main drivers. When you get into consumer, we're looking at home equity being a place that we like and card and Citizens Pay would contribute as well. So that wraps up to a stable year-over-year loans and back to the point around that being taking that otherwise RWA that would have been deployed against auto and some other categories with lower risk-adjusted returns and giving that back to shareholders.

Okay. Great. So, thanks again, everyone, for dialing in today. We certainly appreciate your interest and support. Have a great day.