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

Citizens Financial Group, Inc. (NYSE:CFG) Q4 2023 Earnings Call Transcript January 17, 2024

Citizens Financial Group, Inc. misses on earnings expectations. Reported EPS is $0.34 EPS, expectations were $0.6. Citizens Financial Group, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, everyone, and welcome to the Citizens Financial Group Fourth Quarter and Full Year 2023 Earnings Conference Call. My name is Keeley, and I’ll be your operator today. Currently, all participants are in a listen-only mode. Following the presentation, we will conduct a brief question-and-answer session. 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 2023 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 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.

Bruce Van Saun: Thanks, Kristin. Good morning, everyone, and thanks for joining our call today. 2023 was an incredible year in many respects. With the Fed’s aggressive moves to subdue inflation, the West Coast bank failures, a surprisingly resilient economy, and several significant proposals from bank regulators, it was important in navigating this dynamic environment to focus first on playing strong defense while continuing to play disciplined offense and take advantage of opportunities in the market. Defense starts with the balance sheet and risk management, and I feel really good about how we ended the year. Our capital position is one of the strongest among the large regionals with a CET1 ratio of 10.6%, CET1 adjusted for AOCI of roughly 9% and a tangible common equity ratio of 6.7%.

Our liquidity position is at an all-time best with a loan to deposit ratio of 82%, pro forma Category 1 LCR of 117% and 156% liquidity coverage of our uninsured deposits. Our ACL ratio is at 159% compared to 130% pro forma day 1 CECL, and general office reserves are at 10.2%. We continue to be very disciplined in terms of lending risk appetite and are focused on deep relationships which deliver stronger relative returns. We are using a non-core strategy to run off loans and free capital for better opportunities. On offense, we have several important initiatives we are driving, such as the private bank buildout, the New York City Metro initiative, our focus on serving private capital and growing our payments business. These are all tracking well.

In particular, we are pleased to see the private bank team reach $1.2 billion in deposits soon after our launch in late October. Our financials over the course of the year came under some pressure, primarily given higher funding costs. Nonetheless, we delivered a 13.5% underlying ROTCE for the full year, with a 95% return of capital to shareholders through dividends and share repurchases. In the fourth quarter, we continued to see smaller sequential declines in NII than in the prior quarter as the Fed last hiked in July and the pressure on funding costs has lessened. We saw a modest bounce back in fees, but are very encouraged by the tone of the markets in 2024 to date. Hopefully, we start to see our big capital markets pipelines begin to deliver.

We took some meaningful cost actions in Q4 to set the stage for a very modest expense growth in 2024. We only had the private bank for two quarters, so if you normalize for that, we’re actually reducing the legacy expense base by 1.4%. I should reinforce though that we are doing this while protecting our critical initiatives. Credit outlook continues to track expectations. CRE general office is being carefully managed. Losses are being absorbed in net charge offs. It’s relatively predictable with few surprises so far. Away from that, credit quality is strong. In Q4 we saw a dip in absolute criticized loans and in the ratio which is a promising sign. On the capital front, we did not buy in any stock in Q4, given the charges related to the FDIC special surcharge as well as associated with our cost initiatives.

We expect to be back in the market in Q1, and for that to continue through 2024. Turning to our outlook, we expect NII to continue with modest declines through midyear and then start to tick up. The exciting news on NIM/NII is that we project meaningful benefits from swap and noncore runoff over ‘25 to ‘27, which will power higher EPS and returns. We are poised for strong fee growth led by capital markets. Net charge offs will rise modestly, but we are likely to see ACL releases over the course of the year. Our key priorities for 2024 will be to continue to operate with a strong defense/prudent offense mindset. We have many exciting things on our technology, our digital, data analytics and AI roadmap that we need to deliver on. It’s an exciting time for Citizens.

We feel we are well positioned for medium-term outperformance. I’d like to end my remarks by thanking our colleagues for rising to the occasion and delivering in great effort in 2023. We know we can count on you again in the new year. With that, let me turn it over to John.

John Woods: Thanks, Bruce, and good morning, everyone. I’ll start out with some commentary on 2023. We demonstrated excellent balance sheet strength while delivering solid financial performance. We were resilient through a turbulent environment, benefiting from near top of peer group capital levels and strong liquidity based on stable consumer insured deposits and diversified wholesale funding sources. This strength allowed us to execute well against our multi-year strategic initiatives while opportunistically building out the private bank. On Slide 6, you can see that we delivered underlying EPS at $3.88, which included a $0.51 drag from non-core, and an $0.11 investment in the private bank. Full year ROTCE was 13.5% after incorporating these items.

Before I discuss the details of the fourth quarter results, here are some highlights referencing slides 4, 5, and 7. On the slides you can see we generated underlying net income of $426 million for the fourth quarter and EPS of $0.85. This includes $0.06 for our continued investment in the startup of the private bank and a $0.15 negative impact from the non-core portfolio. We had a significant increase in the impacts from notable items this quarter included on Slide 4. The largest driver was the FDIC special assessment, followed by elevated top and severance related expenses attributable to meaningful headcount reduction. Our underlying ROTCE for the quarter was 11.8%. Our legacy core bank delivered a solid underlying ROTCE of 14.8%. Currently, the private bank startup investment is dilutive to results, but relatively quickly this will become increasingly accretive.

The private bank is off to a very good start, raising about $1.2 billion of deposits through the end of the year, of which more than 30% are non-interest bearing. While our non-core portfolio is currently a sizable drag to results, it continues to run off, further bolstering our overall performance going forward. We ended the year with a very strong balance sheet position with CET1 at 10.6% or 9% adjusted for the AOCI opt-out removal and an ACL coverage ratio of 1.59%, up from 1.55% in third quarter. This includes a robust 10.2% coverage for general office, up from 9.5% in the prior quarter. We continued to build liquidity during the fourth quarter, achieving our planned liquidity profile. Our pro forma Category 1 bank LCR rose to 117% from 109% in the prior quarter.

We also reduced our period end flood borrowings by $3.3 billion quarter-over-quarter to $3.8 billion, and our period-end LDR improved linked quarter to 82% from 84%. Regarding strategic initiatives, as previously mentioned, the private bank is off to a great start and TOP continues to contribute. In addition, New York Metro is tracking well, and we are poised to capitalize on the growing private capital opportunity. Next, I’ll talk through the fourth quarter results in more detail, turning to Slide 8 and starting with net interest income. As expected, NII is down 2% linked quarter, primarily reflecting a lower net interest margin, partially offset by a 2% increase in average interest earning assets. As you can see from the NIM walk at the bottom of the slide, the combined benefit of higher asset yields and non-core runoff were more than offset by higher funding costs and swaps, the net impact of which reduced NIM by 3 basis points to the 3% level.

The additional 9 basis point decline to 2.91% was due to the impact of our liquidity build which was neutral to NII. Our cumulative interest-bearing deposit beta increased a modest 3 basis points to 51%, as the Fed has paused and we see continued but slowing deposit migration. We expect this moderating trend to continue until the Fed eventually cuts rates. Overall, our deposit franchise has performed well with our beta generally in the pack with peers. This is a significant improvement compared to prior cycles when our beta experience was at the higher end of peers. Moving to Slide 9. Fees were up 2% linked quarter given improvement in capital markets and a record performance from wealth. These results were partially offset by lower mortgage banking fees.

The improvement in capital markets reflects increased activity with the decline in long rates in November driving a nice pickup in bond underwriting. Equities improved with strength in the back half of the quarter as the environment became more favorable. M&A advisory fees benefited from seasonality and an improvement in the environment given the better macro and rates outlook, although several transactions pushed to Q1. We see capital markets momentum picking up in Q1 as markets are positive and our deal pipelines are strong. The wealth business delivered a record quarter with higher sales activity and good momentum in AUM growth. The decline in mortgage banking fees was driven by lower production fees as high mortgage rates continued to weigh on lot volumes.

The servicing operating P&L improved modestly while the MSR valuation, net of hedging, was lower. On Slide 10, we did well on expenses which were down slightly linked quarter even while including the impact of the continued private bank startup investment. Our reported expense of $1.61 billion increased $319 million, including notable items totaling $323 million, namely the industrywide FDIC special assessment of $225 million, and the impact of taking cost reduction actions to adjust our expense base heading into 2024. I’ll discuss that in more detail in a few minutes. On Slide 11, average loans are down 2% and period end loans are down 3% linked quarter. This was driven by non-core portfolio runoff and a decline in commercial loans which were 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. Average commercial [line] (ph) utilization continued to decline this quarter as clients remain cautious and M&A activity muted in the face of an uncertain market environment. Next on slides 12 and 13, we continued to do well on deposits. Period end deposits were broadly stable linked quarter with an increase in consumer driven by the private bank offset by lower commercial. The decline in commercial deposits was driven by a proactive effort to optimize the liquidity value of deposits, running off approximately $3.5 billion of higher cost financial institution and municipal deposits during the fourth quarter.

Absent this BSO effect, deposits would have been up by about 1.5% this quarter. Our interest-bearing deposit costs are up 19 basis points, which translates to 51% cumulative beta. Our deposit franchise is highly diversified across product mix and channels with 67% of our deposits in consumer and about 71% insured or secure. This has allowed us to efficiently and cost effectively manage our deposits in the higher rate environment. With the Fed holding steady, we saw continued migration of deposits to higher cost categories with noninterest bearing now representing about 21% of total deposits. This is slightly below pre-pandemic levels, and we expect the pace of migration to continue to moderate from here, although this will be dependent on the path of rates and customer behavior.

Moving on to credit on Slide 14. Net charge-offs were 46 basis points, up 6 basis points linked quarter. We were pleased to see that commercial charge offs were stable linked quarter, and we also saw a modest decline in criticized loans, as we continued to work through the general office portfolio. We saw continued normalization of charge offs in the retail portfolio along with seasonal impacts. Turning to the allowance for credit losses on Slide 15. Our overall coverage ratio stands at 1.59%, which is a 4 basis point increase from the third quarter, primarily reflecting the denominator effect from lower portfolio balances. We increased the reserve for the $3.6 billion general office portfolio to $370 million which represents a coverage of 10.2%, up from 9.5% in the third quarter, as we made modest adjustments to modeled loss drivers.

We have already taken $148 million in charge-offs on this portfolio, which is about 4% of loans. On the bottom left side of the page, you can see some of the key assumptions driving the general office reserve coverage level. We feel these assumptions represent an adverse scenario that is much worse than we’ve seen in historical downturns, so we feel the current coverage is very strong. Moving to Slide 16, we have maintained excellent balance sheet strength. Our CET1 ratio increased to 10.6% and if you were to adjust for the AOCI opt out removal under the current regulatory proposal, our CET1 ratio would be about 9%. Also, our tangible common equity ratio improved to 6.7% at the end of the year. Both our CET1 and TCE ratios have consistently been in the top quartile of our peers, and you can see on Slide 36 in the appendix where we stand currently relative to peers in the third quarter.

We returned a total of $198 million to shareholders through dividends in the fourth quarter. We paused our share repurchases in the fourth quarter in light of the FDIC special assessment. Having exceeded our target capital level for year end, we expect to resume repurchases in the first quarter. Nonetheless, we plan to maintain strong capital and liquidity 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. On the next few pages, I’ll update you on a few of our key initiatives we have underway across the bank, including our private bank and our ongoing balance sheet optimization program. First, on Slide 17, the buildout of the private bank is going very well and clearly gathering momentum.

Following our formal launch in the fourth quarter, our bankers have raised more than $1.2 billion of attractive deposits, with roughly 75% of that from commercial clients. 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 have plans to open a few private banking centers in these geographies, and we are opportunistically adding talent to bolster our banking and wealth capabilities, with our Clarfeld Wealth Management Business as the centerpiece of that effort. Moving to Slide 18, you are all well aware of our efforts in New York Metro. That’s going really well, and we are hitting our targets there. And on the commercial side, as I mentioned before, we are starting to see momentum building in capital markets.

This should translate into a meaningful opportunity for us as the substantial capital backing private equity gets put to work. Next on Slide 19, we continue to be disciplined on expenses. It’s important to remember that a key to Citizens’ success since our IPO has been our continuous effort to find new efficiencies and then reinvest those benefits back into our businesses so we can serve customers better. We’ve effectively executed our TOP 8 program, achieving a pretax run rate benefit of about $115 million at the end of 2023. And we’ve launched TOP 9 with a goal of an exit run rate of about $135 million of pretax benefits by the end of 2024. The new TOP program is focused on efficiency opportunities from further automation and the use of AI to better serve our customers.

We are executing on opportunities to simplify our organization and save more on third party spend as well. Last year, we exited the auto business, and we also exited the wholesale mortgage business in the fourth quarter. We are also adjusting our expense base through further meaningful actions. In the fourth quarter, we reduced our headcount by about 650, or approximately 3.5%, and we have also taken a hard look at our space needs and are rationalizing some of our corporate and back-office facilities. Given all this work, we are targeting to limit our underlying expense growth in 2024 to roughly 1% to 1.5%, with a net decrease in legacy Citizens expenses of 1.3% to 1.5%, being offset by investments in the private bank. Playing prudent defense is at the top of our priority list given the challenging year we saw with the turmoil that began back in March and the uncertain macro outlook.

So, we are reworking both sides of the balance sheet through our balance sheet optimization efforts. Slide 20 provides an update on our efforts to remix the loan portfolio through our non-core strategy and optimization on the commercial side with a focus on relationship based lending and attractive risk adjusted returns. On the left side of the page, you’ll see the relatively rapid rundown of the remaining $11 billion non-core portfolio, which is comprised of our shorter duration indirect auto portfolio and purchased consumer loans. This portfolio is expected to decline by about $6.4 billion from where we were at the end of the year to about $4.7 billion at the end of 2025. And as this runs down, we plan to redeploy the majority of remaining cash paydowns to a reduction in wholesale funding, 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 primarily reallocated to support attractive growth in retail and commercial lending through the private bank. In the broader consumer portfolio, we are targeting growth in the home equity, card and mortgage, which offer the greatest relationship potential. Moving to the right side of the page, we are also working on the commercial portfolio, exiting lower return credit only relationships and focusing on selective C&I lending with multi-product relationship opportunities. We are leading more deals in our front book, improving spreads while also improving the overall return profile of the book. In the appendix, we have included more information covering the broad contours of our BSO program, including how we are managing our high-quality deposit book, remixing our wholesale funding, managing our securities portfolio and positioning our capital base against the backdrop of a changing macro and regulatory environment.

Moving to Slide 21, I will take you through our full year 2024 outlook, which contemplates the early January forward curve and a Fed Funds rate of 4.25% by the end of the year. We expect NII to be down 6% to 9%, with changes in our swaps book contributing to about half of that decline, and average loans down roughly 2% to 3%. However, we expect spot loan growth of 3% to 5%, with private bank growing over the course of the year and commercial activity picking up in the second half. On the deposit side, we expect spot growth of 1.2% — I’m sorry, 1% to 2% and well controlled deposit costs with a terminal beta in the low 50s, before rate cuts are anticipated to begin in May. We expect our net interest margin to trough around the middle of the year and average in the 2.8% to 2.85% range for the full year, and we expect to exit the year around 2.85%.

We’ve included Slide 23, which shows the expected swaps and non-core impact through 2027. In 2024, we expect higher swap expense to be partly offset by the NII benefit from the non-core rundown. You’ll find a summary of our hedge position in the appendix on Slide 38, which demonstrates how the 2024 headwind, which is incorporated in our 2024 NII guide, reverses to a substantial NII tailwind in 2025 and beyond, as the current forward curve is realized. For example, there is an expected improvement in NII contribution from swaps in 2025 year-over-year of approximately $371 million with continued meaningful benefits in 2026 and 2027. Non-interest income is expected to be up in the 6% to 9% range depending upon market environment, led by a nice rebound in capital markets.

We expect expenses to be up about 1% to 1.5%. Excluding the private bank, this would be down 1.3% to 1.5%. We have provided a walk showing the components of our 2024 expense outlook on Slide 22 to provide more context. NCOs are expected to average about 50 basis points for the year as we continue to work through the general office portfolio and expect further normalization in retail. Given macro trends, our remixing of the balance sheet through commercial BSO and the non-core strategy and expectations for modest portfolio growth, we will likely see ACR releases over the course of the year. We plan to resume share repurchases in the first quarter in the $300 million range with more over the course of the year depending upon market conditions and loan growth.

Taking that into account, we still expect to end the year with a strong CET1 ratio of about 10.5%, which is at the upper end of our target range. Putting it all together, we expect to return to sequential positive operating leverage in the second half of the year with PPNR troughing in the second quarter 2024. Moving to slides 24 and 25, as Bruce mentioned, we are well positioned to deliver attractive returns. As we look out over the medium term, we have a clear path to achieve a 16% to 18% ROTCE. We expect to generate solid returns from our legacy core business with a substantial NII tailwind given swap portfolio runoff. We expect to deliver positive operating leverage with strong expense discipline and we are well positioned to grow fees meaningfully given the investments we’ve made in our capabilities over the past few years.

We also expect a meaningful contribution from the private bank as it matures and a tailwind from the runoff of the non-core portfolio as we redeploy that capital and liquidity. We will continue to operate with a prudent risk appetite and focus on returning a meaningful amount of capital to shareholders through our repurchase program and targeting a dividend payout of 35% to 40%. Over the medium term, we expect our CET1 ratio to remain within a target range of 10% to 10.5%, about 50 basis points higher than our prior target range, given continued uncertainty in the macro environment. On Slide 26, we provide the guide for the first quarter. Note that the first quarter has seasonal impacts due to lower day count impact on revenue as well as taxes on compensation payouts impacting expenses.

To wrap up, we demonstrated the resilience of the franchise and maintained strong discipline in 2023 as we worked to position the bank to continue to deliver attractive returns to shareholders over the medium term. We delivered solid results this quarter and we ended the year with a strong capital, liquidity and funding position that puts us in an excellent position to drive forward with our strategic priorities and take advantage of opportunities that may arise. We are continuing to optimize the balance sheet and we are focused on allocating capital where we can drive deeper relationship business and improve performance over the medium term. With that, I’ll hand it back over to Bruce.

Bruce Van Saun: Okay. Thank you, John. Keeley, let’s open it up for Q&A.

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Q&A Session

Operator: Thank you, Mr. Van Saun. We are now ready for the Q&A portion of the call. [Operator Instructions] Your first question will come from the line of Peter Winter with D.A. Davidson. Your line is now open.

Peter Winter: Good morning.

Bruce Van Saun: Good morning.

Peter Winter: Can you guys provide some color on the drivers to that spot loan growth, including some details about the contribution from the private bank and what you’re thinking in terms of commercial line utilization?

John Woods: Yeah, I’ll just start off and others can add. But I mean I think those are the two drivers, as you mentioned. When we look out into primarily the second half of 2024, we are seeing an expectation that commercial activity will pick up. Loan utilization is flattening out here, we expect early in the year. And then so that’ll be part of the driver. We also have had some BSO activity in late ‘23 and early ‘24 that we expect to moderate in the second half of the year as well. So you’re going to see a number of nice tailwinds on the commercial side. And then on the consumer side of things, we are seeing opportunities with good relationship business in the mortgage space and in HELOC, which has been a very nice and consistent driver for us.

But those are the main drivers. Then, of course, broadly, the private bank, which has gotten off to a great start on the deposit side of things in late ‘23, we’re going to see some of that loan opportunity pick up in ‘24. So those are the big, I would say, components of seeing that spot loan growth.

Bruce Van Saun: Maybe, Brendan, you could talk a little bit about what you expect for private bank lending.

Brendan Coughlin: Yeah, sure. Well, I would start by — just a quick comment on Q4 for the private bank. Obviously, strong deposit print and I think demonstrating that the strength of the strategy can be very diversified and led by wealth and deposits and not necessarily requiring low interest lending to dislodge the relationship. So we’re really excited about the print and the start by the team. Having said that, we do expect lending to pick up steam in 2024. Given the interest rate environment, mortgages are obviously challenged on the retail side. So the lending has been more heavily led by commercial lending, which has skewed in the private equity and venture space, which we’re really comfortable with the risk appetite and the profile of that business.

And it’s been critical to start to dislodge personal private banking relationships from the ecosystem of private equity and venture. So we’re off to a really good start. I suspect, given the forward curves, that the first half of the year will continue to be led by commercial principally and private equity and venture lending. Over time, we expect the loan book to be much more balanced and have more retail lending, home equity lending, mortgage lending coming in at scale as the rate environment dictates opportunities there. We also expect to lean into partner loan programs to help connect the corporate side of private equity venture with private banking and personal banking. So you’ll start to see an asset diversification over time, but the first half of the year, we would expect it to still be more heavily weighted on the corporate side.

Bruce Van Saun: Okay. Great. Don, anything to add on the commercial side?

Don McCree: Yeah. I think if you look back at the fourth quarter, the things that dampened our loan growth a little bit were it’s about 50% utilization, 50% BSO with a little bit of bond execution sprinkled in there. So people that were carrying slightly higher balances on the commercial side, a lot of them went to the bond market when rates kind of backed off in the last six weeks of the year. And that’s continued into this year. So I think the particular area that we’re excited about as we get into the back end of 2024 is the private equity space. I mean, that group of clients has been basically dormant for almost two years. There’s lots of conversations going on. We’re hearing from most of those customers that they expect to get a lot more active and that’ll drive utilization on our capital call lines, which is at an all-time low right now. So, I think that’s what the real driver is.

Bruce Van Saun: Great. Peter, did you have another question?

Peter Winter: Yes, just a quick follow-up. That’s helpful. But on just the fee income, you talked about up to 6% to 9%. You did mention, the pipeline is strong for the capital markets, but just if you could give some color on the puts and takes on the fee income side.

Bruce Van Saun: John?

John Woods: Yeah, just kind of the main drivers of that. It’s basically a continuation of some of the trends we’re seeing in the fourth quarter of 2023, where capital markets is starting to pick up again, pipelines are incredibly strong. And I think that the lead driver seems to be M&A advisory. That’s picked up in 4Q, not only due to seasonal factors, but just in terms of a more constructive backdrop. We’re also seeing, as you get in — out into ‘24, pick up and underwriting, both on the bond side and on the equity side, and so — and solid contributions from global markets as well. But — so those are some of the drivers as we see them beginning in Q4, continuing in Q1 with excellent pipelines and playing out over the rest of ‘24.

Bruce Van Saun: You might add something on wealth, Brendan. I don’t know if you want to. We expect continued really strong growth on wealth fees.

Brendan Coughlin: We do, and we spent a year of slow and steady progression continuing to get all-time highs in the wealth management business. But given the private bank investment, 2024 is going to be a really important year. We’re out in the market looking to attract a lot of talent. We’ve made a number of key hires in Q4, both on the leadership side as well as at the advisor side. And so getting the ecosystem of the bankers that we hired in the summer, connected with top and market wealth managers is critical for us. We’re rebranding the platform to Citizen private wealth management to connect the private banking and wealth side together hand in glove. And so we do expect steady and significant growth out of wealth over time really connected into the private banking ecosystem. So we’re pleased with the momentum, but there’s a lot more to come and we hope if we execute well on the private banking initiative.