John F. Woods
Vice Chairman and Chief Financial Officer at Citizens Financial Group
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, an EPS of $0.89. This includes the Private Bank startup 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 startup 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 underlying 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 IV banks, it is worth pointing out that we currently exceed the current LCR requirements for both Category I and III 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.
Cutting 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 mixed 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, 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 pack with 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 through 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 pipelines, 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 startup 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 loan utilization was down slightly this quarter as clients looked 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 slides 11 and 12. We continued 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 or 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. Nonaccrual 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 nonaccruals 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 derisk 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 macroenvironment 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 slides 16 and 17. I'll update you on a few of our key initiatives we have 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 league 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 9 times 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 buildout 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 runs down, 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 and 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 our returns over the medium term, and we are ready to launch on TOP9 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 a program to converge our core deposit system onto a cloud based modern banking platform. We've come a long way 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 Fed holds rates 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 expected 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.
