Citizens Financial Group, Inc. (NYSE:CFG) Q4 2022 Earnings Call Transcript

Citizens Financial Group, Inc. (NYSE:CFG) Q4 2022 Earnings Call Transcript January 17, 2023

Operator: Good morning, everyone, and welcome to the Citizens Financial Group Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Keeley, and I’ll be your operator today. 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, 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 2 of the presentation.

We are also referencing 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. With that, I will hand over to you, Bruce.

Bruce Van Saun: 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 run off 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 expectation 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% and yield to investors of our dividends plus capital return via repurchase put TOP 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.

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John Woods : 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 benefit 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 5. 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 6, 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 7. 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 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 8, 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 9, 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 a 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 a 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 line-up 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 Slide 16 and 17. We filled in all the product gaps. Acquisitions brought us M&A and other advisory capabilities, and we built out debt capital market capabilities organically.

We’ve hired some great coverage bankers and we are focused on high-growth regions around the country and the right industry verticals to serve larger companies. We also have a very strong sponsor coverage and are well positioned to support private equity capital. Bottom line, we have aligned ourselves with the attractive opportunities with a full product set to drive significant market share and fee revenues. Moving to Slide 18. We are excited to announce the launch of our latest TOP program. Even as we push forward on offense with our strategic initiatives and acquisitions, it is important to remember that a key to Citizens success since our IPO has been our continuous effort to find new revenue pools and realize efficiencies and then reinvest those benefits back into our businesses so we can serve customers better.

We’ve effectively executed our TOP 7 program achieving a pre-tax run rate benefit of approximately $115 million at the end of 2022. And we’ve launched TOP 8 with a goal of an exit run rate of about $100 million of pre-tax benefits by the end of 2023, with that split about 80-20 between efficiency and revenue-oriented initiatives. Moving to Slide 19. I’ll walk through the outlook for the full year, which contemplates an economic slowdown and the end of December forward curve view of two 25 basis point Fed hikes before an expected 25 basis point cut in the fourth quarter. We expect solid NII growth, up 11% to 14%, and we project our NIM to gradually rise towards approximately 3.4% for the fourth quarter of 2023. Our overall hedge position is expected to provide a NIM floor of about 3.2% through the fourth quarter of 2024 and a gradual 200 basis point decline across the curve, commencing in Q4 2023.

In the fourth quarter, we took actions to transition $3 billion of active swaps from 2023 to forward-starting positions in 2024. And we’ve done even more so far in January to rebalance the distribution of down rate protection. You’ll find a summary of our hedge position in the appendix on Slide 30. We expect moderate loan growth with average loans up 4% to 5%. We are targeting about $3 billion of spot auto runoff as we shift the portfolio towards products with more attractive risk-adjusted returns. We expect total average earning assets to be up 3% to 4%. On the deposit side, we see 3% average deposit growth and a 2% to 3% spot deposit decline with cumulative deposit betas at year-end reaching the high 30s. These are expected to be up 7% to 9% with a capital markets rebound building over the course of the year.

Noninterest expense is expected to be up roughly 7% or about 3.5% to 4% if you adjust for the full year effect of the HSBC and investors acquisitions and the FDIC premium increase. If the year unfolds as we expect, we should be able to drive about 400 basis points to 500 basis points of positive operating leverage. Given current macro trends and portfolio originations, we expect that our ACL ratio will rise to the 1.45% to 1.5% level, depending upon how the economy fares. We expect our CET1 ratio to land at the upper end of our target range of 9.5% to 10%, even with our target payout ratio approaching 100%. All of this translates into a ROTCE in the high teens for 2023. On Slide 20, we provide the guide for Q1. Note that Q1 is seasonally weak for us with the day count impact and seasonality impacting revenues and taxes on compensation payouts impacting expenses.

Moving to Slide 21. As Bruce mentioned, we have completely transformed the franchise since the IPO, executing well against our priorities and achieving our desired performance targets, and we are ready to raise the bar, lifting our ROTCE target of 16% to 18%. The key to the further ROTCE improvement is continuing to deliver positive operating leverage. As we look out over the medium term, we should see a recovery in loan and deposit growth and we will continue to be balance — continue our balance sheet optimization efforts to focus on deep relationship lending to maximize risk-adjusted returns. We are well positioned to grow fees meaningfully. And even if rates come down a bit, we expect NII to benefit from the protection we have put on through the swap portfolio.

You should expect us to stay disciplined on expenses. Credit is projected to be stable as the economy strengthens. And we continue to focus on returning a meaningful amount of capital to our shareholders through our repurchase program and targeting a dividend payout of 35% to 40%. Over this timeframe, we would expect our CET1 ratio to remain within our target range of 9.5% to 10%. To sum up, Slide 22, we delivered a strong quarter against the backdrop of a dynamic environment, and we have a positive outlook for 2023. We are ready for the uncertainty of an economic slowdown in 2023 with a strong capital, liquidity and funding position. We’ve taken actions to protect our NIM and we are being prudent with respect to our credit risk appetite and loan growth.

At the same time, we are moving forward executing against our strategy and making important investments in our business that we believe will deliver sustainable growth and outperformance over the medium term. With that, I’ll hand it back over to Bruce.

Bruce Van Saun : Okay. Thank you, John. And operator, why don’t we open it up for Q&A?

Q&A Session

Operator: Your first question comes from the line of Scott Siefers of Piper Sandler.

Scott Siefers : It sounds like you guys rebalanced some of the hedges in the fourth quarter and are continuing to do so year-to-date so far. 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?

John Woods : Yes, I’ll go ahead and start off. I mean on the big picture, we — asset sensitivity last quarter was around 3%. We’re a little bit below that this quarter just given the way the outlook for the balance sheet appears to be playing out in 2023. So as we’re — as you’ve seen over time, we’ve taken our asset sensitivity down. We are — most of that asset sensitivity is really driven by the short end of the curve, which we expect to remain elevated throughout 2023. And as a result, we’re looking at some of the down rate protection that we had in place in 2023 and just repositioning that out of spot-starting active swaps into forward-starting swaps into 2024 and beyond. So we’re looking to looking to basically push that out and basically get that down rate protection smoothed out into the ’24 and ’25 periods rather than holding on to all of that down rate protection here in ’23.

That’s the main objective in what we were doing in the fourth quarter, and we’ve done a little bit more of that in early 1Q. And then more broadly, we’re looking at net interest margin, that corridor, if you will, we’re trying to protect that corridor with — at the low end, if rates were to fall by 200 basis points out in 2024, that you’ll see a floor of around 320. So you see that 320 to 340 corridor being something that over time is more narrow than you would have seen from us maybe in past cycles. So that’s the main objective.

Bruce Van Saun : 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.

Scott Siefers : 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?

Bruce Van Saun: Sure. So I think really, you put your finger on it there, Scott, is the capital markets business. We’ve had really strong pipelines this year. But because of the volatility because of the fact that the Fed is still moving higher, that’s created uncertainty and just an inability to actually get the money to work from private equity or some of the deals done because the financing hasn’t been there the way it’s been in the past. And so I think as you — going back to that macro forecast as the Fed is likely nearing kind of the destination in terms of peak rates. I think that starts to loosen up the markets, the financing markets, you’ll see less volatility and a lot of the business is kind of clocked into our pipeline will start to print and get delivered, and we’ll start to see more transactions.

So just by reference, most of the quarters this year, our capital markets revenues were at $90 million to $100 million. If you go back to the fourth quarter of 2021, we had $184 million of fees, so roughly double that level. So we thought coming into this year that we’d have much stronger levels of revenue generation. But the good news is we still have a great overall focus on the right sectors in the market. We’ve got a great team. And so I think you’ll see that start to rev up as we see the market conditions improve. Beyond that, I’m also quite optimistic. We’ve made a lot of investments in the wealth business. And again, there, if you start to see some stability in the asset markets, we should get a kind of tailwind from that plus the investments that we’ve made.

So feel confident about that. And then I’d say mortgage is so washed out. I keep thinking it can’t go any lower, and it did in the fourth quarter. But I think you’re starting to see people exit the business and coming out of the business. And so you’ll start to see margins expand, and I think volumes will tick-up as we go through the year, again, linked back to the Fed reaching the destination and some stability on rates. So those would be the big things. I’m happy to pass the horn here. Don, do you want to say anything else…?

Don McCree: 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.

Bruce Van Saun : Yes. Brandon, anything?