The Citizens Financial Group held a Second Quarter 2023 Earnings Conference Call, with Alan as the operator, Kristin Silberberg as Executive Vice President of Investor Relations, and Chairman and CEO Bruce Van Saun and CFO John Woods providing an overview of their second quarter results. Brendan Coughlin and Don McCree were also present to provide additional color. The company achieved strong financial performance, with a CET1 ratio growing by 30 basis points to 10.3% and repurchasing over $250 million in stock.

Citizens Financial Group grew spot deposits by 3%, improved their loan-to-deposit ratio to 85%, and reduced federal home loan bank borrowings by $7 billion. Non-interest income grew 4%, and expenses were broadly stable. Citizens also secured a significant influx of talent from First Republic to augment their Citizens Private Bank and Wealth Management business. Citizens is also setting up a non-core run-off portfolio and expects $9 billion of loan run-off by the end of 2025, which will be used to fund more strategic loan portfolios, pay down high-cost debt, and build cash and securities. The Private Bank will grow loans by $9 billion, funded by $11 billion of incremental deposits. This will lead to better capital deployment and improved earnings per share, ROTCE, and liquidity.

In the second quarter, the bank generated net income of $531 million and a return on tangible common equity of 13.9%. Net interest income decreased by 3% and the margin was 3.17%, down 13 basis points. Spot deposits increased by 3% or $5.5 billion, while loans and average loans decreased by 2% due to balance sheet optimization.

In the second quarter, the period-end loan-to-deposit ratio improved to 85%, and the company's liquidity position remained strong with FHLB borrowings reduced to $5 billion and available liquidity increased by 19% to $79 billion. Credit metrics and overall position remained solid, with total NCOs of 40 basis points, an ACL coverage of 1.52%, and a strong CET1 ratio of 10.3%. Net interest income was down 3% due to a lower net interest margin of 3.17%, caused by higher funding costs in response to an increase in Fed funds and competitive environment. The company's asset sensitivity and fixed cash flow swap position were similar to the prior quarter.

In a challenging market environment, fees were up 4% from higher transaction volumes and increases in wealth and mortgage banking fees. Expenses were broadly stable and average and period-end loans were both down 2%. Period-end deposits were up $5.5 billion or 3% with growth led by consumer and commercial deposits. Interest-bearing deposit costs were up 47 basis points.

During the second quarter, FHLB levels were reduced by $7 billion due to strong deposit flows and a successful auto loan collateralized borrowing program. The cost of funds increased by 38 basis points. 67% of deposits were consumer-oriented and the portion of insured and secured deposits increased to 70%. Net charge-offs were 40 basis points, up 6 basis points from the first quarter, primarily due to an increase in commercial real-estate. Nonperforming loans increased to 79 basis points of total loans, but overall delinquencies decreased slightly.

The allowance for credit losses was increased by $24 million in the second quarter, with $41 million of that going towards CRE general office. The reserve coverage in general office was increased to 8%, and assumptions for the reserve were based on a stress scenario much worse than seen in historical downturns. A detailed loan level analysis was used to derisk the portfolio, and the assumptions used to set the reserve are more conservative than previous CRE downturns. The financial impact of any further deterioration is expected to be manageable given their strong reserve and capital position.

The company has maintained a strong balance sheet with a CET1 ratio of 10.3%, and returned $461 million to shareholders. They have a conservative approach to capital, liquidity, funding, and credit risk, but are also focused on playing offense. The general office portfolio is 94% Class A or B and mostly in suburban areas. The top 10 MSAs are listed on Slide 15, and in the New York MSA, most of the portfolio is outside of Manhattan. The CET1 ratio is among the highest in the regional bank peer group, and they expect to maintain strong capital levels with the ability to generate 20 basis points of CET1 ratio post-dividend each quarter in 2H '23.

The bank recently hired 50 senior private bankers and 100 related support professionals from First Republic in order to grow their wealth business. This team is located in key markets and serves high and ultra-high-net-worth individuals and families, often with connections to middle-market companies and private equity and venture capital firms. The bank is looking to integrate these teams and ensure that they can deliver their services to their clients.

Clarfeld is opening private banking centers in key geographies and building their wealth business. This will bring in $0.08 to $0.10 of EPS in the second half of the year. By 2025, they expect EPS accretion of around 5% and $9 billion in loans, $11 billion of deposits, and $10 billion of assets under management. To maximize returns, they are focusing on attractive relationship lending and lowering their LDR, which will improve their liquidity profile. They have established a $14 billion non-core portfolio to run down by the end of 2025.

Citizens Access is a digital platform focused on deposits that will be adding checking capabilities later this year. As the non-core loan portfolio runs down, the bank plans to pay down higher-cost funding and redeploy capital into more strategic lending and investment portfolios. The bank is also expanding its relationship-based lending to the private bank and raising deposits to self-fund that growth. In the New York Metro area, the bank is seeing strong sales in the branches and a steady improvement in Net Promoter Scores. On the commercial banking side, the bank has a new leadership team in place with local talent and is seeing early success leveraging its new visibility. The bank plans to converge its legacy core system with the modern platform in the future.

CitizensPay has been the top customer acquisition engine for the bank, and the bank has partnered with companies such as Apple, Microsoft, Best Buy, BJ's and Vivint. The bank has also been executing a consistent strategy for the last 10 years to serve the sponsor community with distinctive capabilities, and has made investments in talent and capabilities. This has resulted in the bank moving up to the top of the sponsor lead tables, particularly in the middle market. The bank is also poised to capitalize on the next wave of sponsor activity as the path of the economy becomes clearer, and has an update on its TOP program.

The TOP 8 program is progressing well and has been augmented to protect returns and make important investments. The TOP 9 program is also underway, looking for efficiency opportunities and automation to better serve customers. The outlook for the second quarter excludes the Private Bank and includes a rate increase followed by the Fed being on hold for the remainder of the year. NII is expected to decrease by 4%, noninterest income by 3%, net interest expense to be stable, and net charge-offs to be stable to up slightly. The CET1 is expected to rise modestly and liquidity position is strong, targeting an LDR of low-to mid-80s by the end of the year.

John Woods discussed the impact of rate changes on their net interest margin and the expected accretion to the margin from balance sheet optimization. He also mentioned that there would be an EPS impact of $0.06 in the third quarter and $0.02 to $0.04 in the fourth quarter due to the private bank drilling up. Lastly, he noted that they are focused on strengthening the franchise for the future and delivering attractive returns.

The Fed is continuing its hiking cycle and the NIM is expected to stabilize around 3% by the end of the year. Balance sheet optimization activities and the Private Bank will contribute to this stability. There will be a cumulative expected EPS drag of $0.08 to $0.10 due to the Private Bank initiatives, with most of the expenses coming in the third quarter. This is a sound approach to scaling up the wealth business.

John Woods answers a question from Erika Najarian about the stability of the 3% level and how the balance sheet trend will affect NII in the fourth quarter of 2023. He states that the NIM should remain at the 3% level, and that the capital outlay will be accretive in the second year, with a 5% accretion in 2025.

In the third quarter, net interest margin is expected to be flat or slightly higher, due to the deceleration of negative deposit migration and the ability to pay down higher-cost funding. In the fourth quarter, net interest margin is expected to continue to hold, bolstered by the runoff block and reallocation of capital and liquidity. This quarter was important for the bank to get the deposit level and Federal Home Loan Bank borrowings lower and lower the loan-to-value ratio. Going forward, the bank does not need to aggressively grow deposits and can have a more stable deposit profile.

John Woods and Bruce discussed how the migration from non-interest bearing to interest-bearing accounts will affect the fourth quarter. Erika Najarian then asked questions about the guidance for the fourth quarter, taking into account potential rate cuts and balance sheet optimization. John Woods replied that the NII for the quarter is likely to be higher than the numbers suggested, and that investors should take into account the potential for rate cuts next year.

The NII is expected to stabilize at a solid level, with the help of the Federal Reserve rate rise. Additionally, the non-interest bearing migration is no longer expected to be a headwind, and the runoff book will be rotated into relationship lending at higher yields. The Private Bank is also expected to contribute to the balance sheet later this year, which is accretive to the overall legacy bank.

John Woods and Bruce Van Saun discussed how the company has a number of tailwinds that should be positive, such as higher spreads in the loan book and security yields that are historically favorable. They believe that balance sheet optimization and the fact that any rate cuts from the Fed would not be happening until 2024, should keep the net interest margin stable into 2024.

Bruce Van Saun is discussing the bank's transition period in terms of loan books and strategy, and how it will affect NII and NIM. He states that the bank has a plan in place to benefit from the transition period and that they are confident in their success in the back half of 2024 and 2025. He also mentions the Private Bank lift-out and that it will have a run rate that will be clarified in their conversation.

Bruce Van Saun and John discussed the potential impact of Basel 3 Endgame on their capital levels. Van Saun mentioned that they are expecting the CET1 ratio to rise to 10.5% by the end of the year, and that they have the ability to repurchase their stock and further increase the ratio. He also mentioned that they are preparing for a potential increase in RWA, particularly for residential mortgages, that may come with the new Basel 3 Endgame regulations.

Gerard questions the proposal that more capital needs to be added to the banking system in response to three bank failures, believing that the issue was caused by poor management and supervisory failures instead. John agrees and adds that the issue is in credit RWA versus operational risk RWA, and that it is expected that there will be some increases in credit risk RWA for regional banks.

The bank is looking to strategically accelerate their Wealth Management business with the hiring of new employees from First Republic. This will include scaling up the bank while aiming to recreate the customer experience from the private banking models. The loans and deposits brought over are expected to be more NII delivering as opposed to fees.

The company is making structural changes to ensure that the business profile is accretive and has a good return profile. They will have a disciplined credit appetite and a rationalized compensation model. The balance sheet will have a mix of cash management, operating deposits, and interest-bearing deposits. On the asset side, there will be a 50/50 mix of consumer personal retail lending and small-business and corporate lending.

John Woods discussed the non-core portfolio, which includes mortgage, home equity, partner loan programs, capital call line lending, and potentially multifamily for high credit environments. The goal is to have an integrated end-to-end business model that is both profitable and stable. He also mentioned that they have done deep diving into the CRE book and there is still work to be done on the commercial side of the portfolio.

Don McCree discussed the BSO activity that has been ongoing for the past three to four years, which is running about $1 billion a year. He explained that they have been able to replace some of that with growth in places like New York Metro, and on the CRE side, they are trying to liquefy multifamily over the next couple of quarters and years. Bruce Van Saun then discussed the capital trajectory from here and that it does still allow for some repurchases, with the pace of buybacks similar to the $250 million done in Q3.

John Woods and Brendan Coughlin discussed how the bank is able to balance the CCAR process while repurchasing shares. They have the ability to reduce RWAs, and are confident that the non-interest bearing mix will stabilize at the 23% level near the 2Q level due to the bank returning to its pre-pandemic platform and the deceleration of deposits migration. They are also seeing positive uptake in their product and low-cost strategy in retail.

The consumer portfolio has been undergoing a five-six year transformation which has resulted in significant improvements in customer primacy, households, and low-cost deposit profile. Data suggests that the consumer bank is better-than-average compared to peers in terms of interest-bearing cost, beta, and low-cost control. The wealthier segment has seen some modest outflows, while the mass-affluent segment has seen deposits remain flat and the mass-market portfolio has seen an increase in net deposits. This is due to product innovation such as getting paychecks two days early and technology that automatically ports over direct deposits.

McCree and Van Saun have been investing in payments capabilities and new products like sustainable deposits to broaden their deposit base. They have been successful in driving primary banking behavior, such as their Peace of Mind 24-Hour Grace program, and are outperforming their peers. They have also developed escrow products, bankruptcy products, and carbon offsets deposits in their ESG strategy. These strategies are helping them to attract operating deposits with a nice breadth.

Bruce Van Saun states that they have a good understanding of their CRE office reserve levels, and they have a good diversification and quality of their loans. They also have people monitoring the loans and being proactive in approaching upcoming maturities. In the first half of the year, they were able to absorb around 30 loans and had an increase in criticized loans, however they also had an increase in NPAs. They also took $56 million in charge-offs, which is an additional 1.5% loss content. Van Saun concludes that it is possible to hold the reserve flat for a few more quarters while absorbing charge-offs.

John Woods and Don McCree discussed the reserves set aside for losses and the charge-off line. They noted that they have 8% set-aside and 9.5% coverage for losses through the cycle, which is strong. They have gone through every single loan one by one and are starting to see outcomes such as extensions and renegotiations with sponsors. The credit and origination teams are focused on working with sponsors in the office sector.

Bruce Van Saun states that they have yet to have a full debrief from the Fed, but they believe that the increase in their stress capital buffer could be attributed to the build of the allowance when they took high charge-offs and questions about whether their hedges were given full benefit. He also states that they have plenty of capital and an appreciable buffer, and they would like to see it get back into line.

John Woods and Manan Gosalia discuss the capital position of the First Republic Bank and the impact of the Bank Secrecy Act (BSO) on the risk-weighted assets and the SCB. Woods explains that the bank's own view of what capital is needed to be prudent is the constraint, and that they will be 200 basis points over the SCB by the end of the year. He also mentions that the BSO gives the bank the flexibility to rotate RWA capital into relationship lending and buy back stock. Vivek Juneja then asks about the pricing assumptions for the First Republic Banker.

Brendan Coughlin and Bruce Van Saun of Citizens Financial Group discuss their relationship-based pricing strategy for mortgages and other asset classes. They will not be offering deeply discounted mortgages, but they understand that larger relationships will result in better pricing. They are not expecting a dramatic different profile in terms of profitability or yields from legacy Citizens.

Don McCree is asked about the level of activity in the market given high rates. He notes that they have put the brakes on to make sure they get the standards they need and that this will help improve customer experience. He also suggests that they will see what level of activity they get back when rates stay high, but it is unlikely to return to the levels of 1.5 years ago.

Pipelines are up 30% from the same time last quarter, and there have been some transactions, such as the Worldpay transaction, indicating that deal formation is beginning. The company tends to play in smaller deals, and was number one in the middle-market leveraged finance league tables in the last quarter. There are a lot of companies in the portfolio that need to sell, and conversations are happening, but it is not expected to be a quick return to 2021 levels. However, it is expected that 2024 could be a good year.

This summary was generated with AI and may contain some inaccuracies.