Citizens Financial Group, Inc. (NYSE:CFG) Q3 2023 Earnings Call Transcript

Citizens Financial Group, Inc. (NYSE:CFG) Q3 2023 Earnings Call Transcript October 18, 2023

Citizens Financial Group, Inc. misses on earnings expectations. Reported EPS is $0.85 EPS, expectations were $0.92.

Operator: Good morning, everyone, and welcome to the Citizens Financial Group Third Quarter 2023 Earnings Conference Call. My name is Greg, and I’ll be your operator today. [Operator Instructions] As a reminder, this event is being recorded. Now I’ll turn the call over to Kristin Silberberg, Executive Vice President, Investor Relations. Kristin, you may begin.

Kristin Silberberg: 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.

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Bruce Van Saun: 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.

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Q&A Session

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 2 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?

John Woods : 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 2Q to 9.5% at the end of 3Q. 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 3Q 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% insurers 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 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.