John Woods
Chief Financial Officer at Citizens Financial Group
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 noncore, and an $0.11 investment in the private bank. Full year ROCE 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 noncore 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 noninterest bearing. While our noncore 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 set one 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 noncore 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 three 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 noncore 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 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 currency 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 Citizen's 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 eight program, achieving a pretax run rate benefit of about $115 million at the end of 2023. And we've launched top nine 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 noncore 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 noncore 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 noncore 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 CNI 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 noncore impact through 2027. In 2024, we expect higher swap expense to be partly offset by the NII benefit from the noncore 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 swabs in 2025 year-over-year of approximately $371 million with continued meaningful benefits in 2026 and 2027.
Noninterest income is expected to be up in the six to 9% range depending upon the 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, a remixing of the balance sheet through commercial DSO and the noncore strategy and expectations for modest portfolio growth, we will likely see ACL 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 noncore 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.
