Citizens Financial Group Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
January 17, 2023

Key Takeaways

  • Citizens delivered strong Q4 results, reporting underlying EPS of $1.32, a ROTCE of 19.4%, an efficiency ratio of 54%, and sequential NII growth of 2% with a NIM of 3.3%.
  • The bank ended 2022 with robust liquidity and capital, including a CET1 ratio at 10%, stable 87% loan-to-deposit ratio, 1% sequential deposit growth, and resumed share repurchases of $150 million.
  • For 2023, Citizens assumes 1% GDP growth, two Fed rate hikes and a late-year cut, projects NIM rising to 3.4% by year-end, ~8% fee growth, disciplined expense growth of 3.5–4%ex-acquisitions, manageable credit costs of 30–35 bps, and ROTCE in the high teens.
  • Strategically, the bank launched its TOP 8 efficiency program targeting $100 million of annual pre-tax benefits, raised its medium-term ROTCE goal to 16–18%, and continued investments in consumer (New York Metro, digital), wealth, and commercial franchises.
  • Proactive risk management actions included boosting the allowance for credit losses to 1.43% of loans and rebalancing interest-rate hedges to maintain a NIM floor near 3.2% through 2024–2025.
AI Generated. May Contain Errors.
Earnings Conference Call
Citizens Financial Group Q4 2022
00:00 / 00:00

There are 12 speakers on the call.

Operator

Good morning, everyone, and welcome to the Citizens Financial Group 4th Quarter and Full Year 2022 Earnings Conference Call. My name is Keeley, and I'll be your operator today. 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.

Operator

Kristen, you may begin.

Speaker 1

Thank you, Kelly. Good morning, everyone, and thank you for joining us. First, this morning, our Chairman and CEO, Bruce Van Thawne and CFO, John Woods, will provide an overview of our Q4 and full year results. Brenda Coughlin, Head of Consumer Banking and Donna McCree, Head of Commercial Banking are also here to provide additional color. We will be referencing our 4th quarter and full year earnings presentation located on our Investor Relations website.

Speaker 1

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.

Speaker 2

Okay. Thanks, Kristen, and good morning, everyone. Thanks for joining our call today. We are pleased with the financial performance We delivered for the Q4 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.

Speaker 3

At the

Speaker 2

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%.

Speaker 2

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 $900,000,000 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 and A fees pushed into Q1 and mortgage results were softer than expected. We maintained stable expenses in the quarter and credit metrics remain good.

Speaker 2

We boosted our allowance for credit losses to 1.43 percent of loans, which compares with pro form a day 1 CECL levels of 1.30%. We restarted our share repurchase activity in Q4, buying $150,000,000 of stock and we ended the year with a CET1 ratio of 10 percent at the top of our targeted range. For full year 2022, we delivered underlying EPS of 4.8 $0.04 and ROTCE of 16.4 percent 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, 2 early Fed rate hikes and a Q4 cut and inflation getting below 3% by Q4.

Speaker 2

We project moderate loan growth, partially offset by continued runoff in our auto book of close to $3,000,000,000 Overall, we see solid NII growth as NIM gradually rises to 3.4% over the year, A roughly 8% growth in fees, given a rebound in capital markets fees over the course of the year solid That's disciplined with core expense growth ex acquisition and FDIC impacts of 3.5% to 4%. We announced today our TOP 8 program, which targets $100,000,000 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 1.5 percent 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 could top 12%.

Speaker 2

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.

Speaker 2

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.

Speaker 4

Thanks, Bruce, and good morning, everyone. Big picture, 2022 is 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.

Speaker 4

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 $115,000,000 of pre tax run rate benefit from 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 Q4, we reported underlying net income of 685,000,000 and EPS of $1.32 Our underlying ROTCE for the quarter was 19.4%.

Speaker 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 end and average loans are broadly stable linked quarter, up 1% excluding auto runoffs. We grew deposits up 1% linked quarter and our LDR was stable at 87%. Fees showed some resilience amid a challenging environment, down 1% linked quarter. We saw a modest improvement in capital markets fees driven by underwriting and M and A, But this was more than offset by a drop in mortgage fees and a CDA DDA impact in our FX and IRP business.

Speaker 4

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 $132,000,000 and a reserve build of $44,000,000 this quarter. Our ACL ratio stands at 1.43%, up from 1.41% at the end of the 3rd quarter at approximately 13 basis points above our pro form a day 1 CECL adoption coverage ratio.

Speaker 4

Our tangible book value per share is up 5% linked quarter. Next, I'll provide further details related to the 4th 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.

Speaker 4

With Fed funds increasing 4 25 basis points since the end of 2021, Our cumulative interest bearing deposit data has been well controlled at 29% through the end of the 4th quarter. Moving on to Slide 7. We posted solid fee results despite headwinds from continued market volatility and higher rates. Fees 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.

Speaker 4

However, underwriting and M and A advisory fees ticked up. The higher rate environment continued to weigh on production volumes. We are seeing pressure on volumes moderating and signs 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.

Speaker 4

On Slide 8, expenses were well controlled, broadly stable linked quarter. Our top 7 efficiency programs delivered over $115,000,000 of pre tax run rate benefits by the end of the year. We are excited to announce the launch 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 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 bring an opportunity for deeper relationships and better risk adjusted returns.

Speaker 4

On Slide 10, average deposits were up $1,400,000,000 a 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 to our deposit mix and capabilities.

Speaker 4

We achieved overall deposit growth this quarter and we will by $1,300,000,000 and increased our cash position at quarterend. Our period end LDR improved slightly to 86.7%. Moving on to Slide 11. We saw 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.

Speaker 4

Nonperforming loans are 60 basis points to total loans, up 5 basis points from the 3rd 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 consumer is fairing. 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 $44,000,000 to take into account the growing risk of an economic slowdown.

Speaker 4

Our overall coverage ratio stands at 1.43 percent, which is a modest increase from the 3rd 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 Cree office. Back on Slide 32 in the appendix, we have provided some additional information about the CREIT portfolio. Our total CREIT allowance coverage of 1.86 percent includes elevated coverage for the office portfolio, while the multifamily portfolio has a much lower reserve requirement.

Speaker 4

The $6,300,000,000 office portfolio includes $2,200,000,000 of credit tenant and life sciences properties, which are not as exposed to adverse back to office trends. The remaining $4,000,000,000 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.

Speaker 4

Tangible book value per share was up 5% in the quarter and the tangible common equity ratios improved to 6.3%. We returned a total of $350,000,000 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.

Speaker 4

We are trying 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 4 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.

Speaker 4

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 lineup and customer focused retail and small business model across the New York market. You will see more details on Slide 2829 in the appendix. Importantly, we achieved about 70% in run rate of our planned $130,000,000 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 Citizens Plus as we orient the business towards financial planning led advice.

Speaker 4

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 So that we can offer a complete digital bank experience to serve customers nationwide with a focus on the young Mass Ave, Lindmark segment. 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.

Speaker 4

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 Fastline process, which is enabled by advanced analytics and digital innovations that have drastically reduced originations time. Moving to the commercial bank on Slide 1617, We filled in all the product gaps. Acquisitions brought us M and A and other advisory capabilities and we built out debt capital markets capabilities organically.

Speaker 4

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've 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.

Speaker 4

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 tools and realize efficiencies and then reinvest those benefits back into our businesses so we can serve customers better. We've effectively executed up our top seven program, achieving a pre tax run rate benefit of approximately $150,000,000 $15,000,000 at the end of 2022. And we've launched Top 8 with a goal of an exit run rate of about $100,000,000 in pre tax benefits by the end of 2023 with that Split about eighty-twenty between efficiency and revenue oriented initiatives. Moving to Slide 19, I'll walk through the outlook for the full year, which should contemplate an economic slowdown and the end of December forward curve view of 2 25 basis point bed hikes before an expected 25 basis point cut in the 4th quarter. We expect solid NII growth up 11% to 14% and we project our NIM to gradually rise towards approximately 3.4% for the Q4 of 2023.

Speaker 4

Our overall hedge position is expected to provide a NIM floor of about 3.2% through the Q4 of 2024 and In the Q4, we took actions to transition $3,000,000,000 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 about 4% to 5%. We are targeting about $3,000,000,000 of spot auto runoff as we shift the portfolio towards products with more attractive risk adjusted returns.

Speaker 4

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. Fees are expected to be up 7% to 9% with the capital markets rebound building over the course of the year. Non interest 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 We should be able to drive about 400 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.

Speaker 4

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 our 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 a day count impact and seasonality impacting revenues and taxes on compensation payouts impacting expenses. Moving to Slide 21.

Speaker 4

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 to 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 And we will continue to 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.

Speaker 4

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 even 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.

Speaker 4

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.

Speaker 1

At the same time,

Speaker 4

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.

Speaker 2

Okay. Thank you, John. And operator, why don't we open it up for Q and A?

Operator

Thank you, Mr. Van Zorn. We are now ready for the Q and A portion of the call. You'll hear an acknowledgment that you've been placed into queue and you can remove yourself from queue at any time by repeating that one zero command. Your first question comes from the line of Scott Siefers of Piper Sandler.

Operator

Your line is open.

Speaker 5

It sounds like you guys rebalanced some of the hedges in the 4th quarter and are To do so year to date so far, I was hoping you might please just expand upon how your thinking on Alco has changed since last quarter and sort How you intend to position yourself? Yes.

Speaker 4

I'll go ahead and start off. I mean, 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 Ashid 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.

Speaker 4

And as a result, we're looking at some of the downside 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 basically push that out and basically get that down rate protection smoothed out into the 20 And smooth out into the 2024 and 2025 periods rather than holding on to all of that down rate protection here in 2023. That's the main objective and what we were doing in Q4 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, then you'll see a floor of around 320.

Speaker 4

So you see that $320,000,000 to $340,000,000 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.

Speaker 2

Yes. And I would just add to that, Scott. And our view in the macro is that the Fed likely moves Maybe once or twice, the forward curve says they'll move up 25 basis points a couple of times and then stop. And then typically they would pause for 6 or 7 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.

Speaker 2

So guided by that view, that's kind of why we're pushing out that downside protection a bit.

Speaker 5

Terrific. Thank you very much. And then, just a separate question. It looks like fees will need to rebound fairly meaningfully following the 1st quarter to hit the guide. I know Bruce you had mentioned an expectation for improved capital markets through the year.

Speaker 5

Maybe just a thought or two on how you see The main drivers of that fee guide as the year progresses, please.

Speaker 2

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 businesses Kind of clocked into our pipelines, we'll 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 $90,000,000 to $100,000,000 If you go back to the Q4 of 20 2021, we had $184,000,000 of fees, so roughly double that level.

Speaker 2

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 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.

Speaker 2

We should get a kind of tailwind from that plus the investments that we've made. So I 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 Q4, but I think you're starting to see people exit the business and capacity coming out of the business. And 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.

Speaker 2

So those would be the big things. I'm happy to pass the horn here. Don, do you want anything else?

Speaker 3

Yes, I think you pretty much covered it on cap markets. I said this last quarter and I'll just remind people again, we are a middle market investment bank. So we're not dependent on these giant transactions that need $5,000,000,000 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 was awash with cash. So there will be transactions.

Speaker 3

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 I think you nailed it pretty well. I'd say Well for the year, we're projecting slow and steady continued progress and it's a bit of a hopeful coiled spring when the Equity markets really come back, but as long as they're stable, we should see some growth. I'd say the other bright spot is debit and ATM fees that continue to hit records both through customer engagement and privacy and all the investments we made in the health of the franchise that's also translating into our deposit quality, Also some restructure on vendor relationships and such that's giving us a bit of a boost there too.

Speaker 3

So that should be a continued area of Slow and steady progress. On the other side, there will continue to be a little bit of pressure still on overdraft income and service charges, But we're sort of near the bottom. Most of that's in the run rate. Most of that's in the run rate. We're sort of near the bottom, which is good.

Speaker 3

That will then Move away from being

Speaker 2

a headwind for us real soon. Okay. Very good.

Speaker 5

That's great. Thank you very much. Yes.

Operator

Thank you. Your next question comes from the line of Peter Winter with D. A. Davidson. Your line is now open.

Speaker 6

Good morning. I wanted to ask on credit. John, you mentioned that most of the increase in nonperforming loans was commercial real estate. And I was just wondering was that office related? And if you can just give a little bit more color on what your outlook is for office?

Speaker 4

Yes. Maybe I'll just talk about the coverage levels. Just broadly, as you may have seen in our materials That the pre coverage from an allowance standpoint is around 186 basis points. But When you carve out some of the really high quality stuff in multifamily and credit tenant lease and life sciences, you get to our general office segment where we have Very healthy coverage of around 5%. So there are some we are seeing some trends there that are telling us that we should be putting away Some reserves to deal with the back to office trends that are headwinds in that space.

Speaker 4

So you get good healthy coverage of around 5%. We are seeing Some of that kick into the non accrual space. I would say more broadly, that will even though that goes into non accrual, our overall pre LTVs are typically around 60%. And so you got to distinguish from non accruals from actual loss content. And so even We're putting some allowance away.

Speaker 4

We feel like that's commensurate with the loss content that we see in the book. And I'll just stop there

Speaker 2

and Don do you want to add?

Speaker 3

Yes. I'll just say for the office portfolio, but Cree in general, It's 1st and foremost who's the sponsor and who's the investor. And we have a very high quality group of investors that we do business with, which are largely Institutional, second is what MSAs are you in and where are you? And we think suburban will do better than urban. And as we said in the comments, we're heavily weighted to Suburban.

Speaker 3

So we're going through every single property in the office portfolio. We'll restructure a lot of them with the sponsors. We've restructured 1 already this year where The sponsor contributed equity. So we're comfortable around where we are with the coverage ratios right now, but we'll be active in restructuring The portfolio, but we kind of like the contours of what we've got.

Speaker 6

Got it. Thank you. And then just as a follow-up, Can you just talk about what changed in the updated margin guidance of towards 3.40 versus the prior guidance of 3.50? Is it just The higher deposit beta outlook?

Speaker 4

Yes. I'll go ahead and cover that. I mean, I think more broadly, it's Two overall comments really. Just given the pace and speed of rate changes and the impact on The migration of the deposit mix that we expect as you get into 2023 is really Most and the majority of what we're looking at. So and that migration manifests itself in 2 ways.

Speaker 4

It's really the amount of DDA The migration that we see as well as the cost of our relatively low cost deposits that we're seeing not only our platform, but across the industry. So from that perspective, just kind of marking that to market with respect to what we're seeing and the trends in the 4th quarter and the rate And curve outlook that we see going throughout the rest of 2023. I would hasten to add What's embedded in there, nevertheless, is a transformed deposit platform that Back prior to the pandemic, we would have had DDA percentages that would be in the low 20s compared with A majority of the portfolio being outside of GDA, of course. But you fast forward to where we are in the Q4 and we're at 28% of our deposit Franchise is sitting in DDA. That's a significant increase versus pre pandemic.

Speaker 4

And we expect to end the year in the sort of the mid to high 20s And the DDA is based down a little bit from where we are today, but nevertheless still very high quality. And when you add in consumer See we and consumer savings, which is other low cost, you end up with still about 50% or more of our Deposit portfolio sitting in low cost categories, that's up from the low 40s prior to the pandemic. So this has been a Multi, multi year transformation of the deposit franchise. So I think we're basically just calibrating What we expect in 2023, which is with the majority of what we saw in terms of the decline from 3.50 to 3.40. I think you could also add in what's going on with the curve and front book, back book as well.

Speaker 4

When you look at just how quickly Rates are rising. The front book originations take a longer time to contribute. And from that perspective, we're seeing that being a driver as well. And then and Not only the speed of I guess the last point I'll make is not only the speed of rates rising, but the inversion of the yield curve is something that It's also pretty is a headwind to front book, back book. Just to end it with, nevertheless, front book, back book is a positive tailwind Over time, we're seeing 300 basis points of positive front book, back book across securities and our Fixed rate lending businesses, that's still a tailwind.

Speaker 4

We're excited and that's going to be a driver into 2023 with net interest margins rising, Just not by quite as much as we thought last quarter.

Speaker 6

Got it. Thanks very much.

Operator

Your next question comes from the line of Ken Usdin with Jefferies. Your line is now open.

Speaker 7

Thanks. Hi. Good morning. Wondering, Bruce heard your early comments about we're at 130 ACL day 1 adjusted for the deals in the low 40s now and your comments about $145,000,000 $150,000,000 year end. I'm just wondering if you can help us given that you're slowing loan growth and letting the auto book run out.

Speaker 7

How do you just help us understand what you're seeing in terms of what your CECL impact might be looking ahead versus the impact of slower loan growth in terms of that Endpoint that you're expecting.

Speaker 2

Thanks. Sure. Yes. I'll start, John. You can pick up.

Speaker 2

But I'd say what we've done for the past several quarters is kind of keep Looking forward as to what's the macro forecast and are there any particular segments of the portfolio that could come under stress Given the Fed has continued to push higher and economic growth has been downgraded. So I think there's I think I read today that over 60% of the leading economists are projecting a forecast for this year. So the reason that we've been building Gradually is just taking that into account. I think at some point, you kind of get the cards turned up in 2023 and you'll have More information and less uncertainty, but we don't see that where we sit today. So I think it's prudent to continue to view the course likely courses that the ACL will go up a couple of basis Points a quarter like we've done and get into that $145,000,000 to $150,000,000 range at some point, then you'll have Seeing whatever the recessionary impact is and then you'll be looking forward and then you may get to the point where you can release some of those reserves depending on what your charge off experience is.

Speaker 2

Clearly, Ken, the slower loan growth plays into that to Some degree is mitigating what the build could have been. But anyway, those are the dynamics at play. John, I don't know if you want to add to that.

Speaker 4

Yes, I'll add that. I mean, just for the last couple of quarters, we've had a mild to moderate recession built into the ACL. And so our peak to trough to GDP decline that we have built into our models are 1.5%. That would be a moderate recession at this point. I think the changes you may have seen in the second half of twenty twenty two were not quite as much on the expectation that there would be A recession as much as what the collateral value outlook really impact was.

Speaker 4

So When you think about house prices and used car prices, etcetera, we've been increasing the amount of decline expected. So you've got sort of the low to mid teens declines now built into our models for both House prices and auto prices over the foreseeable and kind of period. And so that's really and that's not really driving a lot of losses, just we've been having a lot of recoveries in the portfolio over the last year or so. And so you may then You might see some lower recoveries and that will have the you saw our loss that's built into our loss forecast for 2023, but I think that's an important item that you saw in 4Q in terms of our outlook for 2023 and 2024.

Speaker 7

Got it. Okay, thanks. And just one Follow-up on the capital points. You're nearing 100% implies a nice incremental step up in the buyback. I'm just wondering how you're thinking about The mix of the dividend versus the buyback going forward, you obviously moved to $0.42 in the Q3.

Speaker 7

Should we also think about that you would be moving The dividend up in line with increased earnings potential as well within that context?

Speaker 4

Yes. I'd say that what we do here is every year, we're on a cadence. We're post CCAR. We basically take that as the opportunity to broadly update our Capital return profile. Over the medium term, we're looking at 35% to 40% dividend payout And you saw that in some of our medium term outlook.

Speaker 4

We've updated that this is going to be more of a buyback Return year in 2023 because of the outlook for RWAs, but we take a look at dividend policy and earnings outlook and update, whether there should be a change in the dividend accuracy, Carr.

Speaker 2

Yes. And I would just add to that, Ken, clearly with the uncertainty in the environment, we are being cautious in terms of the lending of kind of risk appetite. And so I think that in and of itself creates some additional capital versus what we've had Prior years. I also think we still have our plateful in integration of existing acquisitions and we haven't seen A whole lot that's attractive at valuation that we're interested in on the acquisition front. And so I think the combination of operating at very high profitability levels with ROTCE returns in the high teens Plus more modest loan growth than historical, more modest acquisition activity than historical creates the opportunity.

Speaker 2

And I think it's appropriate given the uncertainty and chance for recession that returning capital shareholders is the right Course of action here. So you could expect we would like to raise the dividend during the course of the year and we'd also like to Get close to that 100% return of capital to shareholders.

Speaker 7

Got it. Great. Thank you, Bruce and John.

Operator

Your next question comes from the line of John Pancari with Evercore. Your line is now open.

Speaker 8

Good morning.

Speaker 4

Hi, Steve.

Speaker 8

On the overall deposit dynamics, I know you expect a 2% to 3% year Over year spot decline. Could you maybe give us a little more color on how you expect overall deposit trends to progress through 2023 to get to that 2% to 3% spot decline, maybe help us with the magnitude of declines that you think is reasonable here in the coming quarters

Speaker 4

Yes, sure. I'll jump in there. I mean, I think Just start

Speaker 2

and then maybe pass it to Don and Brendan. Sure.

Speaker 3

Yes, that sounds good. Yes, I mean,

Speaker 4

I think overall, as I mentioned before, we're seeing deposit migration From a DDA perspective as well as from some of our lower cost levels. But broadly, the mix is superior And improved compared to pre pandemic. I think we're around 28% DDA in 4Q. That's probably going to tick down A bit, call it to maybe 27% or so by the end of the year. That's part of the story.

Speaker 4

I'd say the some of the higher cost Deposits and money markets and savings will be part of the runoff as well, Such that you get to something along the lines of a 2% to 3% decline spot to spot end of 2022 into 2023. And so I'd say that you end up with some again improved mix Compared to pre pandemics, but a little bit of mix softening as you get throughout 'twenty three. And I'll just maybe

Speaker 2

I would just add to that is I'd say we did not take in as much surge deposit As many in our peer group, we have a consumer tilted deposit base, which tends to be more stable. And so we've been monitoring that surge deposits quite carefully and we have seen it Actually be more sticky than we initially expected. I think where you'd see a slight runoff Probably is more on the commercial side where, treasurers have other alternatives besides bank deposits To move some money out, but again, we're relatively protected there because we didn't Take in a lot of that money in terms of search deposits. So maybe Don, you could comment and then Brendan.

Speaker 3

Yes. I think our spot is down a little less than 2% Year to year, we actually ended this year a little higher than we thought we were going to because we had some nice inflow at the end of the year. But back to the I think John said it in his comments, we've really transformed our deposit base really off the back of our treasury services business. From our deposit base really off the back of our treasury services business. So both specialty deposit offerings, we've got 2 that we're now in the market with Around ESG, green deposits and carbon offsets and then just the strengthening of our DDA deposits with our treasury services business gives us More stability than we would have had in prior years.

Speaker 3

So we feel pretty good about that projection. And we're in general, we're really managing the balance sheet from a BSO standpoint and We're avoiding most new transactions given just the shyness around the credit environment and the uncertainty and we're moving clients who aren't generating positive off the franchise and off the balance sheet. So it gives us a little bit of a dynamic that we don't really need to go chase deposits Keeping the loan side relatively modestly in terms of how it grows. Yes. Without being too redundant to what John mentioned, I'd say, consumers have been broadly stable on deposits, which is a really good thing and the story for us is going to be controlling the mix, but all indications They're quite positive.

Speaker 3

We're looking at a lot of benchmarking data and we're pretty confident that we're performing in the top quartile of our peer banks in terms of retention of low cost Deposits as well as interest bearing deposit costs so far in the cycle. It's sort of midway through the cycle, so we've got to stay disciplined and manage it well, but it's Been driven by a lot of health improvements, household growth, improvements in primacy, mix shift to Bruce's point, we were 45% mass affluent and above. 5 years ago, we're now percent of our customer base is massive fluid and above.

Speaker 2

So the

Speaker 3

quality has been quite good. On the stimulus front, what we're seeing is the bottom two deciles Our customer base is essentially back to paycheck to paycheck. So that stimulus has already burned off and is in the rearview mirror. So the stimulus that remains with us tends to be with the more affluent customers, whether that's actual stimulus checks or that's Balance parking that happened during COVID from not making mortgage payments and not traveling, etcetera, etcetera, we're not actually seeing that burn off As much as we're starting to see that rotate out of low cost deposits into interest bearing, which is natural given the state of interest So we're managing that really tight, all the investments we've made in the franchise, whether it's analytics, new products, the introduction of Citizens Plus and our private client group, As well as having Citizens access to fence off interest bearing deposits to maintain discipline in the core have all been Really big levers for us to manage well in all indications we see so far is that we're right on track with where we wanted to be and dramatically outperforming where we were Last time in an up rate cycle and at worst in line with peers, but some signs that we may be doing a bit better, which is

Speaker 4

a big turnaround from where we were 5, 6 years ago. Great.

Speaker 8

Okay, great. Thank you. That's helpful. And then separately, on the commercial real estate front, I know you stated 60% LTVs On overall commercial real estate, is that origination? And then do you happen to have refreshed LTV?

Speaker 8

I know you mentioned that a lot of your deals have sponsor participation, but we're hearing that with sponsors exiting or refinancing out Certain deals that's impacting the LTVs, so the refreshed LTVs may be a better read, particularly on the office front? Thanks.

Speaker 3

Yes. The office the 60% was the office LTVs in terms of not the overall CRE book. So We think those are still pretty good. We're refreshing them property by property. We haven't gone through and done a total refresh on the entirety of the book yet, but We're kind of working on the maturing quarter by quarter maturities and working with the sponsors to either refinance out, Inject equity or adjust the value of the portfolio.

Speaker 3

And that's what drove the NPL this quarter. It was really one real estate deal.

Speaker 8

Okay. Sorry. So that 60% is a refresh number on the office side or is it at origination?

Speaker 3

Those are out origination.

Speaker 9

Okay.

Speaker 8

All right. Thank you.

Operator

Your next question comes from the line of Matt O'Connor with Deutsche Bank. Your line is now open.

Speaker 10

Hey, everyone. This is Nathan Stein on behalf of Matt O'Connor. On capital, So the 9.5% to 10% medium term CET1 target range, that's well above the regulatory minimum. You've built reserves a lot and it seems like the conversion timeline of ISBC is going really well. So I guess my question is why hold so much capital down the road given solid reserves and successful deal integration timeline?

Speaker 2

Yes. I would say part of it is just the philosophy of Liking to have a strong balance sheet. And so I think 9.5 to 10 It is a strong ratio. You've seen over time that we originally had a target of 10% to 10.5% and we've been Kind of sliding that down as we our profitability goes up and I think the stakeholders gain more confidence That we have a good strategy and we're executing well. So it wouldn't surprise me at some point where we start to manage down in that range.

Speaker 2

I think the time of 2023 today when we're looking at a potential recession to be at the top end of that range makes sense. But Once we get to the other side of that to start to move that down and maybe manage that closer to the bottom end of that range, we'll provide More leverage and then at that point, I think we could step back and say, do we still need 9.5% to 10% or can we skinny that down a little bit. So I think that's all in front of us. We thought at this point, given the dynamics around 2023, it wouldn't make sense to actually Move that target range down.

Speaker 10

Okay, thanks. And just second question is just on loans. So the $3,000,000,000 auto runoff will offset growth in other areas this year. What are your expectations for other loan categories in 2023 coming off of

Speaker 4

Yes. I'll go ahead and start there and others can chime in. But I mean, I think when you look out into 2023, we still see very, very strong opportunities in the commercial space And within C and I, and I think something to always keep in mind is our utilization is well below where historical levels would imply we should be. And so as you get into the later part of the year, you see some recovery in investments, in inventories and CapEx and possibly M and A, Which actually provides financing opportunities. We see lots of opportunities across commercial.

Speaker 4

And that's really one of the main drivers. When you get into consumer, We're looking at home equity being a place that we like and Card and Citizens Pay would contribute as well. So all of that wraps up to a stable year over year on loans And back to the point around that being taking that otherwise RWA that would have been deployed against auto And some other categories with lower risk adjusted returns and giving that back to shareholders.

Operator

Your next question comes from the line of Manan Gosalia with Morgan Stanley. Your line is now open.

Speaker 9

Hi, good morning. Good morning. I just wanted to follow-up on the Line of questioning. I think you brought down the floor for NIM from 3.25% to 3.2%. Is that also a function of what you mentioned on the DDA migration and the curve and also the fact that you pushed out the forward swaps?

Speaker 9

Is the biggest variable on that number mostly the cost of funding side or I guess would there be any changes to that 3.2% number of the Fed cuts rates sooner?

Speaker 2

Yes. I'll start and flip to John, it's Bruce. But I think the two numbers are tethered together. So if the $350,000,000 is now seen to be $340,000,000 then Your floor is going to also commensurately move lower. The good news is in a way is that we've tightened the bottom side of that range.

Speaker 2

So Previously it was 3.50 down to 3.20 5. So it's 25 basis points and now it's 3.40 to 3.20. So it's 20 basis points. So anyway, I think we certainly John's initial answer On the movement down has been focused more on migration, the DDA and low cost migration, But then also some of the impact from the yield curve on front book, back book has been the other dynamic. So those are the things that we're watching.

Speaker 2

John, you can pick up from there. Yes.

Speaker 4

So the only thing I'd add, just to remember, we constructed we modeled that $320,000,000 and there's a lot of assumptions that go into that with respect to what the mix So the balance sheet would be etcetera. And what we're assuming is a 200 basis point gradual decline in 2020 4 that would get you down to that 3 20. And given that we are still asset sensitive and we haven't closed out that position, That's really what you're seeing in terms of the decline in net interest margin. So, if as and when We continue to look at ways to lock in protection against down rates. You could see that 3.20 move

Speaker 2

It's a very dynamic process. So we look and see where the forward curve say rates We have our own view of that. We see what the valuations we can get in the hedge market are And you can be assured, I think we played our hand quite well so far and we'll continue to stay really focused on this.

Speaker 9

I appreciate that. And then separately, just on the DOB-eight program, Can you unpack some of the drivers there of the $100,000,000 in pretax benefits and maybe how quickly those can come out from the expense base over the course

Speaker 11

of the year?

Speaker 4

Yes, I'll go and cover that. I'd say the one dynamic to keep in mind is that we tend to form these programs and generate A year end run rate benefit that will contribute for each of them. So on the one hand, the $100,000,000 will build Throughout 2023, so that it gets to a run rate when you get to the Q4 of 2023. But keep in mind, we did the same thing with top 7. So there's a full year effect of top 7 that comes in.

Speaker 4

And so when the programs are reasonably similarly sized, you can almost use that as an estimate of what the contribution is in any given year. And so you have maybe a combined $100,000,000 plus contribution from the full year effective top 7 hitting 23 And the in year effective top 8 hitting 23. And so, the big drivers of that really are in a couple of places. You've got the traditional areas that we focus on, which is 3rd party costs and vendor cost management, which is an area that we've been that's been contributing over the years as well as Continue to optimize the branch network and just being really careful about ensuring that our organizational approach is Fit for purpose with respect to what we're trying to accomplish in 2023. So those are more traditional areas.

Speaker 4

The other places we're looking at that have been more continue to contribute as well. We're working towards a data center exit in 2025. We're looking to migrate to the cloud From our internal applications and that's contributing in 2023 as well. But there's a lot of very strategic Sort of initiatives that are built within the TOP 8 program, we're excited about it. It's part of who we are and we're looking forward to deliver against that next year.

Speaker 9

Great. Thanks for taking my questions.

Operator

Our next question comes from the line of Vivek Janaha with JPMorgan, your line is now open.

Speaker 11

Thanks for taking my questions. A couple of questions for you folks. Firstly, the deposit betas that you expect to get to the high 30s, given the pace of change in the 4th quarter, should we And your expectation for rate hikes early in the year and not after that, should we expect you get to that In Q1, any color on that on the pace of it, especially given how rates have been going up?

Speaker 4

Yes. I mean, I think we will not get there in Q1. That is an over the year expectation in terms of The cumulative growth. I mean, I think you'll see the growth in cumulative betas begin to moderate and flatten out. You get the big jumps early in the cycle.

Speaker 4

So we began and you go way back to the Q2 of 2022, our cumulative data was 6%. And then you get to the Q4, the cumulative beta is 29. So you got 23 points just in 2022. You'll have and then what we're looking for in 2023 is another 9 points. So this is going to and it will increase over time.

Speaker 4

You won't get to 38 in the Q1. It will gradually rise.

Speaker 2

The positives tend to Re priced with a lag. So even after the Fed pauses, you still see a little bit of upward pressure on those betas.

Speaker 4

That's right.

Speaker 11

Okay. But then does that mean, Bruce, the bulk of it is probably early on and just A little further increase after that, after the failure, John?

Speaker 4

I'd say the majority in 1H, and it continues to trickle in, in 2H, And that's built into our outlook.

Speaker 11

Okay. Different question, the second one. Fee income, your guide of about 7% to 9% growth in full year 'twenty three versus 'twenty two. How much of that would you That would come from Capital Markets or at least what's in your forecast that you're thinking? How much comes from Capital Markets?

Speaker 4

Yes. I think there's a big part of it. I mean, I think back to the big drivers, you had Capital Markets and you heard about card fees from Brendan And Will from Brendan as well. So those are the 3 big ones. You see mortgage really Potentially rebounding as well.

Speaker 4

But I think part of it would come from capital markets from the underwriting In M and A advisory, just as we may have mentioned in the Q4, we saw some deals push from 4Q into 1Q. So that's going to Support the Capital Markets business, which by the way over the years has really become a very diversified Capital Markets business itself, I mean, just broadening out M and A Advisory, Underwriting and Loan Syndication, Those businesses really tend to really diversify our overall fee outlook. But yes, a good part of it A good chunk of the growth in 'twenty three comes from Capital Markets.

Speaker 11

Okay. Thank you.

Operator

Thank you. There are no further questions in queue. And with that, I'll turn it over to Mr. Van Song for closing remarks.

Speaker 2

Okay, great. So thanks again everyone for dialing in today. We certainly appreciate your interest and support. Have a great day.

Operator

Thank you. That does conclude today's conference. Thank you for your participation and you may now disconnect.

Powered by Quartr