Citizens Financial Group Inc (CFG) — Q2 2023 Earnings Call Transcript

Thank you, Alan. 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 second quarter 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 second quarter earnings presentation located on our Investor Relations website. After the presentation, we will be happy to take questions. Our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are outlined for your review on Page 2 of the presentation. We also reference non-GAAP financial measures, so it's important to review our GAAP results on Page 3 of the presentation and the reconciliations in the appendix. And with that, I will hand over to you Bruce.

Thanks, Kristin, and good morning, everyone. Thanks for joining our call today. The turbulent external environment continued in the second quarter, but we continue to navigate well and we delivered solid financial performance. In particular, we're pleased with the strong results we achieved around capital, liquidity and funding. Our CET1 ratio grew by 30 basis points to 10.3% in the quarter and we were able to repurchase in excess of $250 million in stock. We grew spot deposits by 3% or $5.5 billion and our spot loan-to-deposit ratio improved to 85%. Our federal home loan bank borrowings dropped by $7 billion to $5 billion and contingent liquidity grew by 20% to $79 billion. For the quarter, we posted underlying earnings per share of $1.04 and ROTCE of 13.9%. NII was down 3% reflecting higher funding costs, in line with our expectations. Non-interest income grew 4%, slightly less than expected as capital markets saw a few deals pushed to the third quarter. The expenses were broadly stable as expected and credit costs continue to be manageable. One of the highlights of the second quarter was the opportunity to secure a significant influx of talent, largely from the First Republic platform, to meaningfully augment our Citizens Private Bank and Wealth Management business. While expense investments will lead revenues in 2023, we project the business to be accretive in 2024 and significantly profitable in the medium term. In our presentation this morning, we will highlight this initiative in more detail. And we'll also review several other compelling initiatives that we believe will lead to strong medium-term outperformance. Execution of these initiatives continues to be strong. We're setting up a non-core run-off portfolio as a centerpiece of intensified balance sheet optimization efforts. We expect around $9 billion of loan run-off, largely in auto, by the end of 2025. This capacity will be utilized to fund more strategic loan portfolios, to pay down high-cost debt, and to build cash and securities. In parallel, the Private Bank will grow loans over this period by $9 billion, which will be funded by $11 billion of incremental deposits. The net benefit of all of this is a better deployment of capital, along with the positive impact on earnings per share, ROTCE and liquidity. We've also included more detail on our CRE loan portfolio. Our general office reserve is now at 8%. While we continue to see increases in criticized assets and charge-offs in this particular portfolio, we believe losses are manageable and readily absorbed by reserves and our strong capital position. Looking forward, we anticipate that the environment while stabilizing will continue to be challenging. Our net interest margin will decline again in Q3, given higher funding costs. We expect our terminal beta to reach 49% to 50% at year end. Our fees will continue to grow sequentially. Expenses will be well-controlled and credit should be broadly stable. We will further build our CET1 ratio while continuing to repurchase shares. Overall, we're holding in okay on current-period performance with mid-teens ROTCE in 2023 while making the investments to deliver a stronger franchise, attractive growth and returns, and afforded by balance sheet over the medium-term. We continue to build a great bank and we remain very excited about our future. Our capital strength and our attractive franchise position us to attract terrific talent and to take advantage of opportunities as they arise. With that, let me turn it over to John to take you through more of the financial details.

Thanks, Bruce, and good morning everyone. Let me start with the headlines for the second quarter, referencing Slide 5. For the second quarter, we generated underlying net income of $531 million and EPS of $1.04. Our underlying ROTCE for the quarter was 13.9%. Net interest income was down 3% linked-quarter, and our margin was 3.17%, down 13 basis points with funding costs outpacing the increase in asset yields. We delivered very strong deposit growth in the quarter, reflecting the strength of the franchise with spot deposits up 3% or $5.5 billion. Period-end loans and average loans were down 2% quarter-over-quarter, reflecting the impact of our balance sheet optimization efforts, including our ongoing run-off of auto. These dynamics improved our period end LDR to 85% and our liquidity position remains very strong. We reduced FHLB borrowings by about $7 billion to approximately $5 billion outstanding at quarter-end and we increased our available liquidity by 19% to about $79 billion. Our credit metrics and overall position remain solid. Total NCOs of 40 basis points are up 6 basis points linked-quarter as expected, primarily reflecting higher charge-offs and increased general office. We recorded a provision for credit losses of $176 million and a reserve build of $24 million this quarter, increasing our ACL coverage to 1.52%, up from 1.47% at the end of the first quarter, with the increase directed to the general office portfolio. We repurchased $256 million of common shares in the second quarter and delivered a strong CET1 ratio of 10.3%, up from 10% in the first quarter. Our tangible book value per share is down 2% linked-quarter, reflecting AOCI impacts associated with higher rates. On the next few slides, I'll provide further details related to second quarter results. On Slide 6, net interest income was down 3%, primarily reflecting a lower net interest margin, which was down 13 basis points to 3.17% with the increase in asset yields, more than offset by higher funding costs, given the competitive environment and migration from lower cost categories. With Fed funds increasing 500 basis points since the end of 2021, our cumulative interest-bearing deposit beta is 42% through the second quarter which has been rising in response to the rate and competitive environment and is generally in the pack with peers. Our asset sensitivity at the end of the second quarter is still approximately 1%, which is broadly stable with the prior quarter. Our received fixed cash flow swap position is similar to the prior quarter as we held off on adding further protection as rates continued to rise during the quarter. Moving on to Slide 7, we posted a solid fee performance in a challenging market environment. Fees were up 4% linked-quarter with card fees showing a seasonally strong increase from higher transaction volumes and increases in wealth and mortgage banking fees. FX and derivatives revenue was modestly lower. Capital markets fees were stable with market volatility through the quarter continuing to impact underwriting fees, largely offset by increased syndications and M&A advisory fees, despite a few deals being pushed into the third quarter. We continue to see good strength in our deal pipelines and are hopeful that deal flow picks up in the second half. Mortgage fees were slightly higher as production fees increased with market volumes, partially offset by lower margins and lower servicing fees. And finally, wealth fees were also up slightly reflecting growth in AUM. On Slide 8, expenses were broadly stable linked-quarter as seasonally lower salaries and employee benefits were offset by higher equipment and software costs, as well as higher advertising and deposit insurance costs. On Slide 9, average and period-end loans were both down 2% linked-quarter, reflecting balance sheet optimization actions in C&I, as well as the impact of planned auto runoff. Education was lower given the rate environment, but this was offset by modest growth in mortgage and from equity. Commercial utilization was down a bit as clients look to deleverage, given higher rates and we saw less M&A financing activity in the face of an uncertain economic environment. On Slide 10, period-end deposits were up $5.5 billion or 3% linked-quarter with growth led by consumer up $3 billion and commercial up $2 billion. Our interest-bearing deposit costs were up 47 basis points, which translates to a 101% sequential beta and a 42% cumulative beta. Strong deposit flows and a very successful auto loan collateralized borrowing program initiated during the quarter contributed to reducing FHLB levels by about $7 billion. Given our BSO objectives, we grew deposits, which drove a favorable mix-shift away from wholesale funding. As a result, our total cost of funds was relatively well-behaved up 38 basis points.

The one thing I would say to that, Scott, it's Bruce, is, this is a very sound approach to scaling up the wealth business. We've been looking for acquisition ideas and it's been very expensive with very long tangible book value earn backs, many times would be over five years, which is beyond our appetite. So to actually do this in a kind of de novo build-up basis, you incur some capital expense in the short run, but it's almost the same as if you kind of equate it to an outlays that ultimately starts to generate revenues. And the nice thing about this is that it's accretive already in the second year and kind of earn-back on this thing is under two years. So we look at it really less as a driver of how does it affect the near-term EPS. But look, there is a capital outlay, which we burn some expense dollars to get it off the ground and then all of a sudden, it's making us money and it really ramps very nicely and can achieve something like a 5% accretion in 2025, which is kind of within 2.5 years, in the second year of doing a deal. If you compare that to some of the other transactions that we've done, including the bank acquisitions, it's pretty darn powerful. So very excited about this opportunity.

Good morning, everybody. Thank you for taking the question. I guess first question is just on the sort of accretion to the margin from the balance sheet optimization. Do you have a sense for what sort of steady-state margin from Citizens might look like after that is completed. I guess, it doesn't necessarily have to be a specific number, but just in your view how powerful is that accretion from these activities? And I appreciate that sort of the backdrop of the 4.2% yield versus the 5.5% funding costs.

Yes, I'll go ahead and start off. Thanks for the question. I mean, I think, broadly, we're seeing the impact of the rate environment on our net interest margin. We're managing it quite well as the Fed is continuing on its hiking cycle. And as you get into the end of the year, taking into consideration all of the balance sheet optimization activities, we see NIM flattening out and kind of holding it around 3% or so, as you get to the end of the year. The tailwinds from balance sheet optimization are meaningful and will continue to build into '24 and so those are the big drivers there, I think that also contributing to that NIM stability would be the fact that we think that balance sheet migration is starting to stabilize. And also you can ignore the fact that the Private Bank itself as you get out into '24, would start to deliver accretive NIM. So we're feeling good about the profile after we get through this last hikes from the Fed here in July, watching that NIM start to stabilize as you get into the end of the year.

And I would comment, Erika, that this was a really important quarter for us to kind of get the deposit level where we wanted to get the Fed - the Federal Home Loan Bank borrowings lower and really take a big step in lowering the LVR. And so we paid up a little bit to achieve that and the impact of that full quarter effects the third quarter guide, but I think at this point, we feel that we don't need to continue to really aggressively grow deposits. We can have a more stable deposit profile. As John indicated, less migration from non-interest bearing to interest-bearing and so there won't be kind of a full quarter impact of an aggressive plan that affects Q4 from Q3 because we'll be kind of looking at a more stable profile in Q3.

Hi, good morning. John, I was just wondering if you can help us with lots of moving pieces that's sort of unfurling in front of us. So, just I guess, the first question is, you noted stability in the 3% - at the 3% level. Does that mean that fourth quarter 2024 will be at about the third quarter level? I'm just wondering sort of how those dynamics play out in terms of what you expect to the - how the balance sheet trend for the rest of the year or those sort of the run-off continue to pressure it at that level and what does that fourth quarter NII about look like from a range perspective.

Yes, I mean, I think from the NIM standpoint, you're talking about '23, just confirming, Erika, is that -

Yes, I'll just close and you got an extended period of time here, Erika, and we're very interested in NII and NIM, which I'm sure is on a lot of investors' minds. But, kind of bigger picture is, we're kind of transitioning the loan book to things that are more strategic and offer better returns on capital and better opportunities for cross-selling deepening with customers. And so we're kind of working through a transition period this year and even into next year. It's a little hard to give you full guidance at this point, given a lot of uncertainty still in the market. We're giving you our best instincts at this point on that. But I feel quite confident that as we kind of emerge through '24 and then even look out to '25, that - kind of with the lift-off of this Private Bank effort and the kind of run-down of these less strategic portfolios that we're going to get a lot of benefit from this and we're really poised to do quite well, I think looking out into kind of back-half of '24 into '25.

Good morning, everybody. Thank you for taking the question. I guess first question is just on the sort of accretion to the margin from the balance sheet optimization. Do you have a sense for what sort of steady-state margin from Citizens might look like after that is completed? I guess, it doesn't necessarily have to be a specific number, but just in your view how powerful is that accretion from these activities? And I appreciate that sort of the backdrop of the 4.2% yield versus the 5.5% funding costs.

Yes, I'll go ahead and start off. Thanks for the question. I mean, I think, broadly, we're seeing the impact of the rate environment on our net interest margin. We're managing it quite well as the Fed is continuing on its hiking cycle. And as you get into the end of the year, taking into consideration all of the balance sheet optimization activities, we see NIM flattening out and kind of holding it around 3% or so, as you get to the end of the year. The tailwinds from balance sheet optimization are meaningful and will continue to build into '24 and so those are the big drivers there, I think that also contributing to that NIM stability would be the fact that we think that balance sheet migration is starting to stabilize. And also you can ignore the fact that the Private Bank itself as you get out into '24, would start to deliver accretive NIM. So we're feeling good about the profile after we get through this last hikes from the Fed here in July, watching that NIM start to stabilize as you get into the end of the year. Yes, without a doubt. I think an important takeaway is how much of this is going to offer a positive story over the balance of the year and as we transition into 2024. We believe that the private bank opportunities are going to yield even greater benefits, and as a result, it's the foundation for a strong trajectory of net interest income going forward.