Citizens Financial Group Inc (CFG) — Q3 2023 Earnings Call Transcript

Thank you, Greg. 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 third 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 third 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 Bruce.

Thanks, Kristin, and good morning, everyone. Thanks for joining our call today. We continue to execute well through a challenging environment. Our focus has been on playing strong defense and maintaining a strong balance sheet. During the quarter, we grew our CET1 ratio to 10.4% near the top of peers, while still buying in $250 million in stock with Non-Core loan runoff of $1.4 billion and deposit growth of $500 million in the quarter, we lowered our spot loan-to-deposit ratio to 84% at quarter end. We focused on building up our liquidity even further, given geopolitical uncertainty and the regulatory direction of travel, adding almost $4 billion to cash and securities. We also built our ACL further to 1.55%, well above our pro forma day 1 CECL reserve of 1.3% and with our General Office reserve now at 9.5%. While the balance sheet has been a principal focus, we continue to execute well on our strategic initiatives, which should drive strong medium-term performance. Our Private Bank is being built out. We had a soft launch during the back half of Q3, and we brought in around $500 million in deposits and investments. Full launch is scheduled over the next several weeks. We're executing well on our New York City Metro push, our deposit strategies, our TOP programs, our ESG initiatives, and our payment strategy. Our underlying EPS for the quarter missed the mark slightly at $0.89 as several capital markets deals slipped from Q3 to Q4, given late quarter market volatility. This was the weakest capital markets quarter since the third quarter of 2020, three years ago and prior to several acquisitions like JMP and DH Capital. The good news here is that the pipelines remain strong, and we continue to maintain and grow our market share. NII expenses and credit costs all track to expectations. We included what we hope is an informative and useful slide in the deck, Page 5, which breaks out results for our legacy core business, our Private Bank start-up investment, and the drag from Non-Core. Note the legacy core performance shows Q3 EPS of $1.08, NIM of 3.33% and ROTCE of 15.3%. The Private Bank should turn positive by mid-'24 and be nicely accretive in 2025 and Non-Core will dramatically run down over the next several quarters. This dynamic will help offset the drag from forward starting swaps and help propel results higher over time. Given the continued macro uncertainty and pressure on revenue from higher rates, we've initiated a zero-based review of expenses in an effort to keep expenses flat in 2024. We'll report further on this on our January call when we give 2024 guidance. For Q4, we expect to see key trends begin to stabilize. NII will decline, but by less than in the past two quarters. Fees should bounce back somewhat, though the extent is market dependent. Expenses and credit costs should be stable, and we should buy in a modest amount of stock given continued solid earnings and loan runoff. This has clearly been a challenging year for regional banks like Citizens. Rest assured, we are working hard. We're navigating the current turbulence well, and we're taking the actions to position us well for the medium term. And with that, let me turn it over to John to take you through more of the financial details. John?

Thanks, Bruce, and good morning, everyone. Let me start with the headlines for the third quarter, referencing Slides 5 and 6. For the third quarter, we generated underlying net income of $448 million and EPS of $0.89, this includes the Private Bank start-up investment of $0.05 and a negative $0.14 impact from the Non-Core portfolio. Our underlying ROTCE for the quarter was 12.5%. On Slide 5, you'll see that we provided a schedule separating out our Non-Core runoff portfolio and the start-up investment in our new Private Bank from our legacy core results, so you can see how those impact our performance. Our legacy core bank delivered a solid underwriting ROTCE of 15.3%. Currently, the Private Bank startup investment is a drag to results, but relatively quickly, this will become increasingly accretive, 5% EPS benefit in 2025. Similarly, while Non-Core is currently a sizable drag to revenues, it will run off quickly, further bolstering our overall performance and partially mitigating the expected impact of forward starting swaps. Back to Slide 6. Total net interest income was down 4% linked quarter, and our margin was 3.03%, down 14 basis points, both in line with expectations. Deposits were up slightly in the quarter, reflecting the ongoing resilience of the franchise. We continued our balance sheet optimization efforts, further strengthening liquidity during the quarter given the uncertain geopolitical environment and in preparation for potential changes to liquidity regulations, increasing cash and securities by about $4 billion. In addition, the Non-Core portfolio declined by $1.4 billion, ending the quarter at $12.3 billion. While we await clarity on new liquidity rules for Category 4 banks, it is worth pointing out that we currently exceed the current LCR requirements for both Category 1 and 3 banks. Our period-end LDR improved to 84%, while our credit metrics remained solid with net charge-offs of 40 basis points, stable linked quarter. We recorded a provision for credit losses of $172 million and a reserve build of $19 million this quarter, increasing our ACL coverage to 1.55%, up from 1.52% at the end of the second quarter with the increase primarily directed to raising the General Office portfolio reserves from 8% in Q2 to 9.5% at the end of Q3. We repurchased $250 million of common shares in the third quarter and delivered a strong CET1 ratio of 10.4%, up from 10.3% in the second quarter. And our tangible book value per share decreased 3% linked quarter, reflecting AOCI impacts associated with higher rates. Turning to Slide 7 on net interest income. Linked-quarter results were down 4% as expected, primarily reflecting a lower net interest margin, which was down 14 basis points to 3.03%. As you can see from the walk at the bottom of the slide, the decrease in margin was driven by deposit repricing, which includes mix shift from lower cost to higher interest-bearing categories, noninterest-bearing deposit migration as well as the mix impact of the liquidity build I mentioned earlier. These factors were mitigated by positive impacts from asset repricing and rundown of the Non-Core portfolio. Our cumulative interest-bearing deposit beta is 48% through Q3 and which has been rising in response to the rate cycle and competitive environment. Our deposit franchise has performed well with deposit betas generally in the back of peers. This is a significant improvement compared to prior cycles when our beta experience was at the higher end of peers. Our sensitivity to rising rates at the end of the third quarter is roughly neutral, down slightly versus the prior quarter. Moving to Slide 8. Fees were down 3% linked quarter, driven primarily by lower capital markets and card fees, partly offset by the increase in mortgage banking fees. The Capital Markets fees outlook was positive early in September, but with market volatility and higher long rates picking up to the end of the month, we saw a number of M&A deals pushed into the fourth quarter, resulting in lower linked quarter M&A advisory fees as well as lower bond underwriting. While we continue to see good strength in our deal pipeline, uncertainty continues around the timing of these deals closing given the level of market volatility. Card fees were slightly lower, reflecting lower balance transfer fees. The increase in mortgage banking fees was driven by higher MSR valuation; the servicing P&L provides a diversifying benefit, which in the quarter more than offset the decline in production as higher mortgage rates weighed on lock volumes. On Slide 9, we did well on expenses, keeping them broadly stable linked quarter, excluding the $35 million Private Bank start-up investment. On Slide 10, average loans are down 2% and period end loans are down 1% linked quarter. The Non-Core portfolio runoff of $1.4 billion drove the overall decline, partly offset by some modest core growth in mortgage and home equity. Average core loans are down 1%, largely driven by generally lower loan demand in commercial, along with exits of lower returning relationships and our highly selective approach to new lending in this environment. Period-end core loans are stable. Average commercial line utilization was down slightly this quarter as clients look to deleverage given the environment and higher rates. We saw less M&A financing activity in the face of an uncertain economic environment. Next, to Slide 11 and 12. We continue to do well on deposits. Period-end deposits were up $530 million linked quarter, with growth led by commercial and consumer deposits broadly stable. Our interest bearing deposit costs were up 39 basis points, which translates to a 48% cumulative beta. Our deposit franchise is highly diversified across product mix and channels, and with 67% of our deposits in consumer and about 70% insured secured. This has allowed us to efficiently and cost-effectively manage our deposits in this rising rate environment. As rates rose in the third quarter, we saw continued migration of lower-cost deposits to higher-yielding categories with noninterest-bearing now representing about 22% of total deposits. This is back to pre-pandemic levels and we would expect the decline to moderate from here, although this will be dependent upon the path of rates and consumer behavior. Moving to credit on Slide 13. Net charge-offs were 40 basis points stable linked quarter with a decrease in commercial, offset by a slight increase in retail driven by auto, which normalized following a very low second quarter result. Non-accrual loans increased 9% linked quarter to 87 basis points of total loans, reflecting an increase in General Office. We feel the rate of increase in non-accruals is decelerating after a jump in Q2. Turning to the allowance for credit losses on Slide 14. Our overall coverage ratio stands at 1.55%, which is a 3 basis point increase from the second quarter, which reflects a reserve build of $19 million as well as the denominator effect from the rundown of the Non-Core portfolio. We increased our General Office coverage to 9.5% from 8% in the second quarter. You can see some of the key assumptions driving the General Office reserve coverage level, which we feel represent a fairly adverse scenario that is much worse than we've seen in historical downturns. As mentioned, we built our reserve for the General Office portfolio to $354 million this quarter, which represents coverage of 9.5% against the $3.7 billion portfolio. We have already taken $100 million in charge offs in this portfolio, which is about 2.5% of loans. In setting the General Office reserve, we are factoring in a very severe peak-to-trough decline in office values of about 68% with a remaining 18% to 20% default rate and a loss severity of about 50%. So we feel the current coverage of 9.5% is very strong. It's worth noting that the financial impact of further deterioration beyond our outlook would be manageable given our strong reserve and capital position. We have a very experienced CRE team who are focused on managing the portfolio on a loan-by-loan basis and engaging in ongoing discussions with sponsors to work through the property and borrower specific elements to de-risk the portfolio and ultimately minimize losses. I should also note that about 99.2% of CRE General Office is in current pay status. Moving to Slide 15. We have maintained excellent balance sheet strength. Our CET1 ratio increased to 10.4% as we look to grow capital given the dynamic macro environment and new capital rules proposed by the bank regulators. We returned a total of $450 million to shareholders through dividends and share repurchases. We plan to maintain strong and growing capital and liquidity to levels that fortify our balance sheet against macro uncertainties and position us to quickly transition to any new regulatory rules that may impact banks of our size. Turning to Slide 16 and 17. I'll update you on a few of our key initiatives underway across the bank, so that we can deliver growth and strong returns for our shareholders. First, on Slide 16, we've included just a few of the business initiatives we are pursuing to drive improving performance over the medium term. On the commercial side, we highlight how we are positioned to support the significant growth in private capital. Although deal activity has been relatively muted recently, many sponsors have meaningful amounts of capital to deploy. So there is a tremendous amount of pent-up demand for M&A and capital markets activity given the right market conditions. We have been serving the sponsor community with distinctive capabilities for the last 10 years and we've established ourselves at the top of the middle market sponsor lead tables. And our new private bankers will significantly expand our sponsor relationships, and we stand ready to leverage our capabilities in this space when sponsor activity picks up. We also think there is a tremendous opportunity in the payment space, and we've been investing in our Treasury Solutions business developing integrated payments platforms and expanding our client hedging capabilities. On the consumer side, our entry into New York Metro is going very well with some early success attracting new customers to the bank and growing deposits about 9x faster than in our legacy branches, as we leverage our full customer service capabilities to drive some of the highest customer acquisition and sales rates in our network. The build-out of the Private Bank is also going very well. These bankers have hit the ground running and have already brought in around $500 million in deposits and investment balances through a soft launch in the back half of Q3. This is a coast-to-coast team with a presence in some of our key markets like New York, Boston, and places where we'd like to do more like Florida and California. We plan to open a few Private Banking centers in these geographies and build appropriate scale in our wealth business with our Clarfeld legacy Wealth business as the centerpiece of that effort. Turning to Slide 17 on the top left side is our balance sheet optimization program, which is progressing well. The chart illustrates the relatively rapid rundown of the Non-Core portfolio, which is comprised of our $9 billion shorter-duration indirect auto portfolio and purchased consumer loans. This portfolio is expected to decline by about $7.6 billion from where we are now to about $4.7 billion at the end of 2025, and as this rundown occurs, we plan to redeploy the majority of cash paydowns to building core bank liquidity with the remainder used to support organic relationship-based loan growth in the core portfolio. The capital recaptured through reduction in Non-Core RWA will be reallocated to support the growth of the Private Bank. In summary, this strategy strengthens liquidity has already been a source of about $3 billion of term funding ABS issuance this year. It builds capital by reducing RWAs and it's accretive to NIM, EPS and ROTCE. Next to our TOP program on the right side of the slide. Our latest program is well underway and on target to deliver a $115 million pretax run rate benefit by year-end. Our TOP programs are essential to improving returns over the medium term, and we are ready to launch on top 9, looking for efficiency opportunities driven by further automation and the use of AI to better serve our customers. We are looking at ways to simplify our organization and save more in third-party spend as well. In light of pressure on revenue given the rate environment, we are targeting to keep 2024 underlying expenses flat. On the technology front, we have a very extensive agenda with a multiyear next-gen tech cloud migration, targeting the exit of all of our data centers by 2025 and the program to converge our core deposit system onto a cloud-based modern banking platform. We've come a long way in modernizing our platform since the IPO. And on the ESG front, we recently announced a $50 billion sustainable finance target, which we plan to achieve by 2030 and commitment to achieve carbon neutrality by 2035. And we are working diligently to help our clients prepare for and finance their own transitions to a lower carbon economy. Moving to the outlook for the fourth quarter on Slide 18. Our outlook incorporates the Private Bank and assumes that the Federal rate remains steady through the end of the year. We expect NII to be down approximately 2% next quarter, given the impact from noninterest-bearing and low-cost deposits migrating to higher cost categories, albeit at a decelerating rate, more than offsetting the benefit of higher asset yields, Non-Core runoff, and day count. Based on the forward curve, we expect the cumulative deposit beta at the end of 2023 to be approximately 50% and to rise to a terminal level of low 50s percent before the first rate cut. Noninterest income is expected to be up 3% to 4% with a seasonal pickup in capital markets depending on the market environment. Noninterest expense should be broadly stable, which includes the Private Bank and excludes the anticipated FDIC special assessment. Net charge-offs are expected to rise to approximately mid-40s basis points as we continue to work through the General Office portfolio and expect further normalization. We feel good about our reserve coverage around the current level and the ACL level will continue to benefit from loan runoff. Our CET1 is expected to increase to approximately 10.5%, with the opportunity to engage in a modest level of share repurchases, the execution of which will depend upon our ongoing assessment of the external environment. Beyond the 4Q '23 guidance, as I mentioned earlier, we are targeting flat 2024 underlying expenses. This includes the Private Bank and the Non-Core portfolio and excludes the anticipated FDIC special assessment. Also, we've included Slide 25 in the appendix on the swaps impact through 2027. We expect higher swap expense in 2024 to be partly offset by the benefit to NII from the Non-Core rundown. Notably, the swap expense drag will reduce meaningfully over 2025 through 2027 as swaps run off and the Fed normalizes short rates. In addition, the impact of terminated swaps is dramatically lower in '26 and 2027. To wrap up, we delivered solid results this quarter while navigating through a dynamic environment. Importantly, we made good progress positioning the company with a strong capital, liquidity, and funding position, which will serve us well as regulatory requirements are finalized and if the environment becomes more challenging. Our balance sheet strength also positions us to take advantage of opportunities through our strategic priorities as we continue to strengthen the franchise for the future and deliver attractive risk-adjusted returns. With that, I'll hand it back over to Bruce.

Okay. Thank you, John. Greg, why don't we open it up for some Q&A.

My first question is for John. John, there has been a lot of feedback from investors on uncertainty over the NII trajectory for '24 in the environment of higher for longer. And I think you know where I'm going here. I think that investors are trying to sort of square the $11 billion, $12 billion increase in notional swaps, right, at a received fixed rate of 3.10% in the second half of next year and trying to square that in a higher for longer environment with some of the balance sheet optimization. So if you could just sort of take us through a little bit of the moving pieces and perhaps simplify it for the investors listening in terms of how that impacts your NII trough timing, what happens after you hit trough and are you still confident in what you said, I guess, a month ago and that you could exit 4Q '24 with a 3% NIM?

Thanks, Erika. I'll address that in reverse order, which may help with our discussion. The net interest margin came in as anticipated in the third quarter at 3.03%. Two major factors to consider as we look toward the fourth quarter are our ongoing deposit migration and its expected impact. Overall, I foresee another mid-single-digit headwind for the fourth quarter regarding the entire balance sheet, excluding liquidity build. As a result, the net interest margin is expected to be close to 3%. Despite ongoing migration, it seems to be holding steady at our expected level. Additionally, due to the current uncertainty in the regulatory environment, we have made significant efforts to increase liquidity. This liquidity build is neutral to net interest income but does have a minor effect on the net interest margin, which contributed about two basis points in the third quarter and could result in several additional basis points in the fourth quarter. Overall, we expect things to unfold as planned in the fourth quarter. Looking ahead to 2024, after resetting the table in the fourth quarter, the key considerations include the growing swap portfolio, which remains stable in the first half of the year before rising in the second half. This is also around the time the forward curve suggests potential rate cuts. Therefore, when assessing the outlook, the swap portfolio could indicate that the Fed may start cutting rates in the second half of 2024. The ongoing benefits of the Non-Core portfolio, contributions from the Private Bank, and the impact of current long rates will all positively influence asset management. Additionally, our balance sheet optimization efforts will play a significant role. We need to see how the rate environment develops; the forward rates present one scenario, while Bloomberg economists suggest a consensus that is about 50 basis points lower than those forwards. Regardless, we anticipate this will lead to manageable outcomes and potentially growing momentum as we approach the end of 2024 with a net interest margin around 3%.

And just to clarify, are you still confident that you could exit 4Q '24 with a net interest margin of about 3%? Based on what you're telling us, it sounds like if the Fed doesn't cut as the forward curve indicates, that would pose a risk to that 3%.

Yes. I think in the fourth quarter, I'd say that we're all else equal we're getting around that 3% level, depending upon the impact of liquidity builds, which are NII neutral. That is that liquidity build piece that I would say, which is kind of sort of set that aside, just given where we are, it doesn't drive NII. So you're thinking about the net interest margin that drives NII, we're going to be in that neighborhood of 3% ex liquidity build.

Got it. And I'm going to step back after this because I think I'm taking up too much time. I just want to clarify I'm asking about 4Q '24. Are you talking about 4Q '23? I just wanted to make sure we were on the same page.

In the fourth quarter of 2023, I want to clarify that we are targeting around a 3% level, give or take, excluding the liquidity build, which is neutral to net interest income (NII). So, when considering NII, it's approximately a 3% level excluding the liquidity build. For 2023, and considering all the factors we discussed earlier, going into 2024, we expect tailwinds from Non-Core, Private Bank, asset front book, back book, and BSO, which will help support us as we assess the impact of potential rate cuts in the latter half of 2024. We will evaluate our position as we close out 2024, and we will provide additional insights in January, as we customarily do, taking into account all the various influences and conditions at that time.

I would like to revisit the fourth quarter margin to ensure we’re all aligned. The reported margin seems likely to be below 3%, but it appears you are expecting some liquidity build. Is it reasonable to assume we will see something in the mid-2.90s for the reported expectation?

It will be lower. It depends on the appropriate liquidity build that we have determined. It's helpful to discuss an ex-liquidity build since that drives net interest income, and there might be additional variability in cash funding. This will impact net interest margin but won't be a driver of net interest income, and it could take the margin below the plus or minus 3% I mentioned earlier.

Yes. All right. Perfect. As we consider the transition from the Non-Core loan runoff to more noticeable growth in the Private Bank, when can we expect this to become more stable regarding visibility on the balance sheet? When do we anticipate the loan portfolio to level out?

We believe that the Non-Core runoff will continue to be a significant factor, especially in the fourth quarter and the first half of 2024, where we anticipate some declines in the loan portfolio. However, by the second half of 2024, we expect the Private Bank to start contributing, along with organic growth leading to loan growth, which should result in year-over-year loan growth beginning in the latter half of 2024.

I was wondering about the credit side; we have recently observed some pre-announcements regarding charge-offs in the shared national credit area. Can you remind us of your exposure to shared national credits and how you performed in the recent exam?

So do you want me to take that, John?

Sure.

In general, there's significant attention on shared national credits. During this year's exam, we experienced more upgrades than downgrades, and we did not incur any forced charge-offs related to our shared national credit portfolio. As part of our BSO exercise, we've reduced our participations, which are now about 10% lower than they were a couple of quarters ago. We approach participations and shared national credit deals the same way we do with any other credit extension. Each deal must provide a return, and we follow the same process whether we're participating, leading a transaction, or acting as a sole lender. Additionally, we conduct a comprehensive credit analysis for every extension we make, irrespective of whether it involves shared national credits. Our SNC portfolio performs on par with our other portfolios, and in some instances, because they are larger credits, they may perform slightly better than a few of our middle-market assets over time.

Yes. And I think just as part of BSO, as Bruce said, as part of BSO in general, we're kind of looking at the total relationship returns. And if we went into credit as a participant thinking we can kind of move left and become a more important bank, that's not panning out. We're not getting the cross-sell we anticipated, then we're extricating ourselves at the next available opportunity. So I think you'll continue to see that trend.

Yes. And let me just pick up on that. Just in the last quarter, back to the loan growth question, we had about $900 million front book loan originations, offset by about $1.6 billion of BSO activity. So we're really churning the book towards full relationship credits and away from some of those participations that Bruce mentioned. And I think a lot of the competition is doing exactly the same thing. We see people supporting their lead bank relationships and moving away from more speculative future opportunities.

Got it. Can you provide more details on the deposit repricing and migration and how you anticipate it will be affected by the longer period of high rates and the impact on deposit pricing pressures?

Yes, I'll take care of that. First, when we consider our deposit beta performance, we believe we are in line with what the industry is experiencing, which is a positive development compared to the last cycle. This reflects the ongoing investments we’ve made in enhancing our service offerings and overall customer experience. We are pleased with how things are progressing so far. Regarding the noninterest-bearing deposits, we are currently at about 22%, which is similar to pre-pandemic levels. We have observed a slowdown in the movement from noninterest-bearing to interest-bearing accounts, and there is also a deceleration within the interest-bearing category. Nonetheless, the size of this migration is decreasing each quarter. We anticipate this trend to continue diminishing over the next couple of quarters, particularly late in the cycle when the Federal Reserve is maintaining rates. Overall, we are optimistic about this direction.

Yes. Maybe, Brendan, do you track very carefully how we're doing versus peers and some of our strategies to continue to maintain that low-cost focus. So maybe you can add some additional color.

Yes, sounds good. So much of our low-cost deposit book is in the consumer space and obviously was buoyed through the pandemic by all the stimulus. We saw the rundown of the stimulus rate peak in May, and it started to abate as we got into the summer and the fall, although it's still kind of spending down at a decent clip. We do have a lot of analytics, benchmarking analytics on how we're doing, and this is supportive of John's commentary that the franchise is performing in a very different level than it did the last upgrade cycle. We believe we're #2 in the peer set in terms of DDA consumer migration. So we're performing exceptionally well on the DDA side. And when you look at beta on the consumer side, as compared with the growth that we're getting, it appears for about 400 basis points to 500 basis points better in net growth on the consumer book through the cycle so far, and our betas are mildly better. So more growth is slightly better cost on the core book. That's excluding Citizens Access. That's a real indicator of the quality of the franchise and the quality of the customer base that we've moved from sort of a community banking, high-priced deposit focus to deeply engaged primary banking relationships. So we expect the pay down of low-cost deposits to continue to slow, obviously, dependent on the rate environment, and that potentially could change. What I do feel really confident in is that our relative performance to peers will be strong and we'll continue to outperform on the consumer side and the stability of our low-cost book. At the individual customer level, they still have a little bit more liquidity in their balances than they did pre-pandemic; that's largely held by affluent and high net worth individuals, our mass market book; and even in the mass affluent space, they've sort of moderated back down to operating floors. So I think those are all signs that would support the continued slowdown in the rundown of low-cost deposits pending any recessionary impact that may bring them below operating floors. So we feel pretty good. And just on the uninsured and insured deposit front, we saw a little bit of a blip on the uninsured in March. Since March, that has been incredibly stable, and all parts of the book have been growing. So all the fundamentals point to a continued trajectory of stability and certainly continue to outperform. And then in addition to that, we're controlling what we can control. We are performing in the top quartile in the United States in terms of household acquisition growth. The New York market, as John pointed out, is helping to give us an extra lever to drive low-cost deposit growth over and above just the portfolio trends, which are generally outperforming. So we do believe we've got a distinctive amount of levers for the franchise to continue to outperform in the medium-term outlook on low-cost deposits.

Very helpful. I just want to confirm, John, you mentioned that the expense outlook for next year is expected to be flat. Does that include the expenses for the Private Bank build-out?

Yes. The underlying expenses to be flat next year, including the Private Bank as well as Non-Core.

Just a follow-up on that last question. John, I just wanted to ask you, I know that the Private Bank buildout was $35 million of cost this quarter. Just wondering if there's any changes to your expectation of what that would trend like going forward as part of that cost commentary?

I think Brendan will likely provide more details on this. It's quite similar as we move into the fourth quarter, and looking ahead to next year, we anticipate it shifting towards breakeven by 2024 instead of negatively impacting EPS. Additionally, we project a 5% contribution to EPS in that timeframe.

Yes, we anticipate some modest increases in the low 40s as we move into Q4. This is largely due to the majority of our team being hired in early summer, which has positively influenced our ability to secure various Private Banking offices across the country. These offices will help us bring customers onto our platform, and we're also managing some operating expenses as clients join us. Additionally, we are focusing on select second-tier offices. We continue to see a lot of talent available, and in this quarter, after bringing on the initial 150, we added another 25 top-tier professionals across the same offices opened in the summer. We will remain selective, but we intend to onboard the right talent as they become available.

The other thing, just in the way the comp is structured, Ken, that the folks who came over on guarantees as if they're fully producing. So as the revenues come in, there won't be incremental costs. They'll just be kind of earning those pay levels. So another factor to consider.

Yes, that's a great point. And then as a follow-up, you guys have done a great job over the years on the TOP program, and just I take your commentary about holding costs flat, inclusive of these extra builds that would imply a real turn exiting the year given that you ramped through the year on cost this year. And John, I know you mentioned AI as a piece of that increment. But you've done 100 plus of TOP each year. I'm just wondering like where else would you be digging in across the organization to get that magnitude of what seems to be a pretty meaningful implied extra cost saving out of the numbers next year.

So it's Bruce. And let me start off and then John can amplify. But the TOP program, I think, has been a real consistent contributor to our ability to deliver positive operating leverage. But to actually get to flat for next year, we have to go beyond that. So we've geared up a very nice TOP program and we're adding to it. But I think we're going to have to look at kind of employment levels broadly to see where we can extract some folks and we'll look at certain business activities that may be less important going forward than what we have been engaged in historically. We've already done some of that this year. So we downsized the mortgage business quite a bit. We exited the auto business. So I think it's a combination of actions. It's continuing to find ways to upsize TOP, leverage things like AI, where we can do that, look at our overall board structure and staffing levels to see if we can pinch some efficiencies there and then look hard at our business mix and figure out where the key years not to just have a knee-jerk revenues, there's revenue pressure in the environment. So let's really take a hard knife at all expenses. We have to be judicious about where we're cutting and protect the things that we feel are really going to help us grow and outperform in the medium term. So things like the private banks, things like the New York Metro expansion. There's things that we're going to ring fence and then there's other areas we're going to have to go a little harder with the knife. John?

Yes, I think that covered it well, Bruce, and just ongoing the fundamentals, our bread and butter of focusing on organizational related items and third-party spend and the like. And I won't repeat all the categories that Bruce articulated, but we've got a fundamental underpinning that we feel like we have the opportunity to broaden out with while protecting the initiatives that are going to help us outperform over the medium term.

You have 67% of deposits from consumer, so a strong franchise there. And you noted that you should outperform peers on a relative basis. But one of your large peers noted last week that banks may still be overearning on NII. So I guess my question was, how do you see competitive factors playing out for consumer deposits next year, especially if the rate environment stays higher for longer?

Brendan, do you want to?

We have definitely observed ongoing intense competition for consumer deposits. Money market and CD rates are currently in the mid-5s in some areas. We believe we’re competing effectively in this environment, primarily due to our focus on low-cost operations, which provides a strong foundation for maintaining healthy net interest income and net interest margin levels. We have more options available to navigate whatever competitive challenges we face in 2024. Citizens Access has proven to be a valuable tool for attracting interest-bearing deposits while fostering strong, lasting relationships. This approach also minimizes the risk of attracting short-term deposits that could disrupt our retail banking model. Additionally, where we have matched the aggressive rates in our core franchise, we've done so with a focus on building relationships. Access to higher deposit rates for our core banking customers requires being part of a relationship product, such as our Quest or private client offerings for affluent customers. This strategy allows us to offer more to those who engage more with us, enabling a targeted approach to managing interest-bearing costs while effectively retaining deposits. The competitive landscape is challenging, and we anticipate this will continue into the first half of the year as deposits remain scarce in the U.S. banking system. However, we are confident we have the right tools and strategies in place to continue to effectively compete with our peers.

To add to that, the rate environment is expected to improve. If you are raising deposits in a situation where the yield curve is inverted or only slightly less so, it can create challenges for banks until the conditions stabilize and transition to a more favorable upward slope. This is likely to happen as we move into 2024, particularly by the end of that year, when we anticipate lower short-term rates and still attractive long-term rates that will allow us to effectively deploy our capital for a positive return. That is what I believe will unfold as we progress into 2024.

I mean, the other one last piece of color I would add is that as we enter 2024, we're still kind of having a net loan shrink, and that will eventually turn around as the Private Bank starts to put on loans, and we'll see where the economy is. But we won't really need to we're not pressured to grow deposits given that dynamic on loans. We can still see the LDR improve just by keeping loans stable or even letting them drop a little bit. So factoring that into the calculus of do you really need to be aggressive given that's your dynamic around loans and deposits that helps you manage the cost of your deposit franchise.

Great. I appreciate all the color there. And just separately on the LCR requirements, you mentioned that you're compliant in both Category 1 and Category 3 now and that this build is also NII neutral. But I guess the question is, how much more do you think you need to build from here? And how do you think about that increasing your asset sensitivity in the long run?

Yes, I believe there are a couple of questions within that. The regulatory requirements are generally prompting banks to become more asset sensitive. If the long-term debt rule is implemented, along with the need to hold shorter-duration liquidity, that will likely increase our asset sensitivity over time. We are naturally an asset-sensitive bank, and these factors will make us even more asset sensitive. Therefore, we will need to assess during the transition periods whether it makes sense to adjust those positions through various balance sheet actions. Nevertheless, the regulatory environment is generally providing a tailwind for asset sensitivity, and particularly for us, the runoff of our Non-Core portfolio, which is largely fixed, contributes to that tailwind. Currently, we are around neutral. So, over time, we could see a modest increase in asset sensitivity due to these underlying factors. We will determine how to manage that as the situation evolves. Additionally, the liquidity build is neutral regarding net interest income, so it's not a driving force. The projected decline in net interest income of 2% mainly stems from a decline in net interest margin, which is responsible for that 2% figure in our guidance. This summarizes our outlook for the fourth quarter.

A lot of talk earlier in the call in terms of net interest income trajectory for next year and all the puts and takes. But I just wanted to circle back on that. In a stable rate environment to kind of higher for longer, when and around what level does the interest income dollars start to bottom?

We are currently in the process of finalizing our outlook for 2024, and we intend to be more transparent about our expectations as we approach the planning season. This will be more defined by January. Looking at our swap portfolio as we head into 2024, we anticipate growth that coincides with when the market expectations suggest the Fed may start to lower rates. However, we believe that rates could end up being slightly lower than what the projections indicate for the end of 2024. This will act as a mitigating factor, along with the rundown of Non-Core assets and the growth in Private Banking, which will be beneficial. As we move into 2024 and look further ahead to 2025 through 2027, we expect a more stable Fed stance, regardless of the transitions in 2024. This should create a significant tailwind as our swap portfolio has a more neutral effect on net interest margin and net interest income. Overall, while 2024 may serve as a transition year with the Fed normalizing rates, we are confident that our balance sheet optimization and the Non-Core assets will generate strong momentum as we look towards 2025 and beyond, especially with anticipated benefits from the terminated swaps.

Yes, I would like to provide some additional context regarding Matt and Erika's question. Erika wanted to know if John could confirm that we are still targeting a 3% for the fourth quarter of this year and the fourth quarter of next year. The hesitance to commit to a 3% figure stems from the current liquidity situation and the fact that some regulatory guidelines regarding new liquidity regulations have yet to be finalized. Setting that aside, if we view this as somewhat uncertain, our goal remains to have our exit rate at the end of 2023 align closely with the exit rate at the end of 2024. We still aim to achieve this, although we will need to navigate the budget process for next year.

In terms of the impact of rate cuts compared to a scenario of rates being higher for a longer period, what is the difference? It appears you are still somewhat sensitive to the impact of rates, but the benefits from the roll-on of swaps would come from rate cuts. What would be the overall impact if rates remain stable compared to the forward curve predictions for next year? Is the outcome better or worse?

Yes. I would say that we are currently in a neutral position. A slight increase in rates is actually beneficial for our platform. We usually evaluate this using a 100 basis point and 200 basis point gradual rise, and we remain relatively neutral in those assessments, which you can find in our 10-Q disclosures. In terms of any further rate hikes or discussions around that, we generally continue to generate profit and see a positive effect on net interest income in those environments. Overall, the forward curve looks favorable to us, and we appreciate how it’s tracking. We anticipate rate cuts starting at the end of '24, which will be beneficial for our front book and back book. We also prefer that the long end remains anchored at a slightly higher level, as it supports our fixed-rate loan originations. Additionally, this situation offers us opportunities to lock in higher rates if we choose to do so. Overall, the forward curve is constructive for us; minor fluctuations are acceptable. However, significant movements in either direction could present challenges. Other than that, we feel relatively comfortable with the situation.

Okay. So to summarize, steeper is better as a good rule of thumb?

The forward curve looks positive, and minor fluctuations won't significantly affect us. In general, banks perform better when we have an upward sloping yield curve. Currently, short rates are at 5.50, but we see them more favorably at around 3.00 to 3.50 in the long run. We also believe a 10-year rate above 4% in that context is beneficial. A gradual decrease from 5.50 to between 3.00 and 3.50 over the next two years would be advantageous for both us and the industry, helping to revert to an upward sloping yield curve, which would create a favorable environment for our performance. However, we are prepared to adjust our strategy if the rate environment changes significantly. Ultimately, that scenario aligns best with our interests and the industry's overall health.

I have a couple of clarifications regarding our discussions. John, when you mentioned expenses, you indicated that underlying expenses would be flat next year. However, you also stated that this includes Private Bank and Non-Core. Since Non-Core isn't part of how you define underlying expenses, are you suggesting that both underlying, which is core, and reported expenses will remain flat next year?

No, I'd say underlying expenses at the top of the house will be flat next year, '24 versus '23. Underlying includes Private Bank, it includes Non-Core overall CFG expenses will be flat in '24 versus '23.

Underlying does not exclude those things today; the back that includes those things.

Okay. So I want all these definitions; everybody has a little difference, so it's important to clarify that. The second one, I guess, John, going back to the rate discussion, just to get my head wrapped around that. If I heard you right, just in response to Matt's question, is that small increase in rate is beneficial to NII. But then rate cuts are also positive. So I'm trying to reconcile how both scenarios are positive for you?

Yes, I can clarify that, Vivek. A small increase in rates from here would lead to a slight increase in net interest income, while a small decrease would result in a minor negative impact on net interest income. However, both changes are relatively small, which is why we consider our position to be neutral. From a positioning perspective, a rate increase would be marginally beneficial, especially if there was one additional hike, for instance, if the Federal Reserve raises rates in the fourth quarter. This would contribute positively to net interest income. On the other hand, a small cut would have the opposite effect but would not significantly affect our net interest income. It's important to note the distinction between immediate effects in the next quarter and long-term impacts. We remain optimistic about a gradual decline in rates, with short-term rates potentially dropping to around 3% to 3.5% over a series of quarters. This scenario is favorable as it allows time for balance sheets to adjust, and ensures both new and existing loans remain beneficial, supporting a healthy balance sheet transition over the next year or two as we optimize our balance sheet with non-core runoff, among other factors. Overall, our balance sheet is set to perform well with an upward trajectory, which we expect to see continue into 2024 and early 2025.

And one more clarification, that's helpful. On the expenses, Bruce, when you talk about stability for next year, what are you assuming for capital markets? Are you anticipating that capital markets revenues and consequently incentive compensation will increase? Or are you just considering current levels? Any insights on that?

Yes. Well, we haven't given the full guidance yet on '24, but there is a variable element of pay that if revenues go up in capital markets that pay would go up. That's probably the one area that has the rates tied to revenues across the bank. And we would have to contemplate that as we go through the budget process. So we said we're targeting the flat expenses for next year, and we would incorporate our view on kind of where the capital markets fees are going to be and then what additional payouts would result from that. And then we'd have to find ways to offset that elsewhere in the bank.

Okay. Thanks again for dialing in today. We certainly appreciate your interest and support. Have a great day. Thank you very much.