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spk08: Your conference will begin momentarily. Please continue to hold.
spk09: Good morning, everyone, and welcome to the Citizens Financial Group third quarter 2023 earnings conference call. My name is Greg, and I'll be your operator today. Currently, all participants are in a listen-only mode. Following the presentation, we will conduct a brief question and answer session. As a reminder, this event is being recorded. Now I'll turn the call over to Kristen Silberberg, Executive Vice President, Investor Relations. Kristen, you may begin.
spk01: Thank you, Greg. Thank you, Greg. Good morning everyone and thank you for joining us. First this morning our Chairman and CEO Bruce Van Saan and CFO John Woods will provide an overview of our third quarter results. Brendan Coughlin, Head of Consumer Banking and Don McCree, Head of Commercial Banking are also here to provide additional colour. We will be referencing our third quarter earnings presentation located on our investor relations website. After the presentation we will be happy to take questions. Our comments today will include forward-looking statements which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are outlined for your review on page two of the presentation. We also reference non-GAAP financial measures, so it's important to review our GAAP results on page three of the presentation and the reconciliations in the appendix. And with that, I will hand over to Bruce.
spk04: Okay, thanks, Kristen, and good morning, everyone. Thanks for joining our call today. We continue to execute well through a challenging environment. Our focus has been on playing strong defense and maintaining a strong balance sheet. During the quarter, we grew our step one ratio to 10.4% near the top of peers, while still buying in 250 million in stock. With non-core loan runoff of 1.4 billion, and deposit growth of $500 million in the quarter, we lowered our spot loan-to-deposit ratio to 84% at quarter end. We focused on building up our liquidity even further, given geopolitical uncertainty and the regulatory direction of travel, adding almost $4 billion to cash and securities. We also built our ACL further to 1.55%, well above our pro forma day one CECL reserve of 1.3%, with our general office reserve now at 9.5%. While the balance sheet has been a principal focus, we continue to execute well on our strategic initiatives, which should drive strong medium-term performance. Our private bank is being built out. We had a soft launch during the back half of Q3, and we brought in around $500 million in deposits and investments. Full launch is scheduled over the next several weeks. We're executing well on our New York City Metro push, our deposit strategies, our top programs, our ESG initiatives, and our payment strategy. Our underlying EPS for the quarter missed the mark slightly at 89 cents as several capital markets deals slipped from Q3 to Q4, given late quarter market volatility. This was the weakest capital markets quarter since the third quarter of 2020, three years ago and prior to several acquisitions like JMP and DH Capital. The good news here is that the pipelines remain strong and we continue to maintain and grow our market share. NII expenses and credit costs all track to expectations. We included what we hope is an informative and useful slide in the deck, page five, which breaks out results for our legacy core business, our private bank startup investment, and the drag from non-core. Note the legacy core performance shows Q3 EPS of $1.08, NIM of 3.33%, and ROTC of 15.3%. The private banks should turn positive by mid-24 and be nicely accretive in 2025, and non-core will dramatically run down over the next several quarters. This dynamic will help offset the drag from forward starting swaps and help propel results higher over time. Given the continued macro uncertainty and pressure on revenue from higher rates, we've initiated a zero-based review of expenses in an effort to keep expenses flat in 2024. We'll report further on this on our January call when we give 2024 guidance. For Q4, we expect to see key trends begin to stabilize. NII will decline, but by less than in the past two quarters. Fees should bounce back somewhat, though the extent is market dependent. Expenses and credit costs should be stable, and we should buy in a modest amount of stock given continued solid earnings and loan runoff. This has clearly been a challenging year for regional banks like Citizens. Rest assured, we are working hard. We're navigating the current turbulence well, and we're taking the actions to position us well for the medium term. And with that, let me turn it over to John to take you through more of the financial details. John?
spk02: Thanks, Bruce, and good morning, everyone. Let me start with the headlines for the third quarter, referencing slides five and six. For the third quarter, we generated underlying net income of $448 million and EPS of 89 cents. This includes the private bank startup investment of $0.05 and a negative $0.14 impact from the non-core portfolio. Our underlying ROPSI for the quarter was 12.5%. On slide five, 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 ROTC 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 six, 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 4 banks, it is worth pointing out that we currently exceed the current LCR requirements for both Category 1 and 3 banks. Our period-end LDR improved to 84%, while our credit metrics remain 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 bill 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 set one 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. Starting to slide seven 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 mixed shift from lower cost to higher interest-bearing categories, non-interest-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 eight, 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 valuations. 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 an 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 and core loans are stable. Average commercial line 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 length 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% insurer 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 non-interest 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. Non-accrual 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 non-accruals 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 three 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 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 pre-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 de-risk the portfolio and ultimately minimize losses. I should also note that about 99.2% of Cree general office is in current pay status. Moving to slide 15, we have maintained excellent balance sheet strength. Our set one ratio increased to 10.4% as we look to grow capital given the dynamic macro environment 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. Starting to slide 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 lead 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 nine times faster than our, 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 build-out 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 Clark Feld 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 EBS issuance this year. It builds capital by reducing RWAs, and it's accretive to NIM, EPS, and ROTC. 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 pre-tax 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 top nine, 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 multi-year 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 in 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 non-interest-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. Non-interest income is expected to be up 3 to 4 percent with a seasonal pickup in capital markets, depending on the market environment. Non-interest 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 SEP 1 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 4Q23 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 FLAT 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 make 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.
spk04: Okay, thank you, John. Greg, why don't we open it up for some Q&A?
spk09: Okay. Ladies and gentlemen, if you'd like to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press 1 then 0 at this time. And one moment, please, for your first question. Your first question comes from the line of Erica Najarian from UBS. Please go ahead.
spk00: Hi, good morning.
spk09: Morning.
spk00: My first question is for John. John, there has been a lot of feedback from investors on, you know, uncertainty over the NII trajectory for 24, you know, in the environment of higher for longer. And I think you know where I'm going here. I think that investors are trying to sort of square the $11, $12 billion increase in notional swaps at a received fixed rate of $3.10 in the second half of next year and trying to square that in a higher for longer environment with some of the balance sheet optimization. So if you could just sort of take us through a little bit of the moving pieces and perhaps simplify it for the investors listening in terms of you know, how that impacts your NII trough timing, you know, what happens after you hit trough, and are you still confident in what you said, I guess, a month ago, and that you could exit for Q24 with a 3% NIMH?
spk02: Thanks, Eric. Maybe I'll take that a little bit in reverse order because it might help us with the jump-off conversation. So net interest margin came in as expected in the third quarter, so we'll talk about that at 3.03. I think that the two big forces that I would talk about broadly as you look out into the fourth quarter would be our basic, you know, ongoing deposit migration and how that is expected to play out. So I'd say that, you know, if you look at overall net interest margin, you know, I'd say that we're going to see another so-called mid-single-digit sort of headwind into the fourth quarter just on the entire balance sheet outside of liquidity bills. And so that 303 kind of comes in right around that 3%. So that's kind of playing out the way we expected, notwithstanding the fact that we are seeing ongoing migration. I'd say that that's holding about where we think it should be. The other item, as you may have seen in some of our walks in the slide deck, is the fact that given the uncertainty and regulatory environment, we've endeavored to actually build liquidity in a much more meaningful way. That liquidity bill is NII neutral, but it does have a nominal impact to the net interest margin. And so you could see that being an impact in the fourth quarter. It was a couple, you know, maybe two basis points or so in the third quarter. That could be maybe another, call it, you know, several basis points as you get into the fourth quarter. So you can see things playing out as we expect in the fourth quarter. When you basically get to – The 2024 dynamics, once you reset the table in the fourth quarter, the big puts and takes are we do have the swap portfolio increasing as you get into – it's flattish when you get into the first half of the year, but it rises in the second half of the year. It happens that as it relates to 24, that's about when the forward curve would start implying that cuts are starting to come in. So I'd say that when you think about some of the mitigants to the outlook with a swap portfolio, you're going to have you know potentially the fed beginning to cut in the second half of 2024 you have the ongoing benefit of the non-core portfolio you've got the growing um accretive contributions from the private bank um and with you know long rates being where they are you know asset front book back book is is a is a kind of will contribute positively and then just the broader balance sheet optimization efforts that we're doing across the bank i think are all the uh the areas that i would highlight as nice mitigants to what we're seeing play out. You know, let's see where the rain environment plays out. I mean, the forwards have it in one place. We have, you know, Bloomberg economists' consensus are probably 50 basis points lower than where the forwards are. But, I mean, nevertheless, we see this potentially playing out to a very manageable and, frankly, growing momentum as you exit 2024 on the net interest margin.
spk00: And just to clarify... You know, are you still confident that you could exit, taking all that into account, exit 4-2-24, have a NIM of about 3%, and based on sort of what you're telling us, it sounds like the, you know, if the Fed doesn't cut as the forward curve indicated, that would be the risk to that 3%.
spk02: Yeah, I think in the fourth quarter, I'd say that we're all else equal. We're getting around that 3% level, depending upon the impact of liquidity bills, which are NII neutral. It's that liquidity bill piece that I would say, which is kind of sort of set that aside, just given where we are, it doesn't drive NII. So when you're thinking about the net interest margin that drives NII, you know, we're going to be in that neighborhood of 3% ex-frequency build.
spk00: And I'm going to step back after this because I think I'm taking up too much time. I just want to clarify, I'm asking about 4Q24. Are you talking about 4Q23? I just wanted to make sure we were on the same page.
spk02: 4Q23, yeah. Sorry, I need to make sure that was clear. Everything I was just saying was about in that last bit was that we're getting around that 3% level, give or take, in 4Q23, ex-liquidity billed, and the liquidity billed is NII neutral. So if you're trying to think about where we're driving NII, it's around that plus or minus 3% level X liquidity bill. For 2023, and all the other forces that we talked about earlier, as you're going into 2024, when I was ticking off the tailwinds from non-core private bank, asset front book, back book, and BSO. All of those are tailwinds into 24, which will be mitigants along with, let's see where the rate cuts actually start kicking in in the second half of 24. And we'll see where we exit 2024, but, you know, that's something we'll come back to you on, you know, in terms of adding more color, you know, in January as we typically do. And we'll assess our environment and all of those forces and puts and takes at that time. Great. Thanks.
spk09: Your next question comes from the line of Scott Seifers from Piper Sandler. Please go ahead. Hey, guys. Thank you for taking the question.
spk08: I guess I want to revisit that fourth quarter margin just to make sure everybody's on the same page. But the reported margin, it sounds like, will be below the 3%, however, right? Because I know it'll be dependent on liquidity build, but it sounds like you do anticipate liquidity build. So we'd be talking kind of something in the mid-290s. Would that be sort of the reported expectation?
spk02: It will be lower. You know, it just depends on the NII neutral liquidity bill that we determined to be appropriate. So it's sort of, I think it's useful to talk about the next liquidity bill, given the fact that that's the driver of NII. And there'll be possibly additional, you know, just in terms of the variability of cash and how that gets funded, that's flat to NIAG. It'll be a denominator effect that would take the NIM below that plus or minus 3% that I talked about before, but not an NAI driver.
spk08: Yeah, okay. All right, perfect. And then maybe as we look at just in terms of sort of the handoff from the non-core loan runoff to NIAG, more visible private bank growth, when do we sort of think that will become sort of more neutral in terms of visibility to the balance sheet? Like when would we expect a loan portfolio to sort of level out?
spk02: Yeah, I think that we were saying that we think that the non-core runoff will be a continued driver of sort of in the first half of – in 4Q, in the first half of 24, you'll see some declines in the loan portfolio. But in the second half of 24, we start seeing the private bank contributing more. as well as organic contributions starting to see loan growth such that, you know, year over year we would have an expectation you'd see us starting to see loan growth in the second half of 24. Okay.
spk08: All right. Perfect. All right. Thank you very much.
spk09: Your next question comes from the line of Peter Winter from D.A. Davidson. Please go ahead.
spk12: Thank you. I was wondering on the credit side, we've just seen in general some pre-announcements on charge-offs in the shared national credit space. Can you just remind us what your exposure is to shared national credits and how you fared in the recent exam?
spk13: Do you want me to take that, Jim? Sure. Just in general, as I think, there's a lot of focus on shared national credits. Actually, when we came through the exam this year, we had more upgrades than we had downgrades. So we didn't have any forced charge-offs in terms of our shared national credit book. We've been taking our participations down as part of our BSO exercise. They're about 10% lower than they were a couple quarters ago. i you know i think there's a lot of focus on shared national credit we treat participations or share national credit deals exactly as we treat every other uh credit extension so one it has to return um people think about it as hanging paper and then deploying loans and not returning we go through the exact same process whether we're participating or leaving a transaction or a sole lender and then also we do full credit analysis of every single extension that we make, whether it be a shared national credit extension or not. So our SNCC book doesn't perform any worse than any other book that we have in the bank. And actually, in some cases, it's larger credits, so they might perform marginally better than some of the middle market assets that we have on the book over time.
spk04: And I think just as part of... we're kind of looking at the total relationship returns. And if we went into a credit as a participant thinking we can kind of move left and become a more important bank, that's not panning out. We're not getting the cross-sell we anticipated. Then we're extricating ourselves at the next available opportunity. So I think you'll continue to see that trend.
spk13: Yeah, and let me just pick up on that. Just in the last quarter, back to the loan growth question, we had about $900 million in a front book loan originations offset by about a billion six of BSO activity. So we're really churning the book towards full relationship credits and away from some of those participations that Bruce mentioned. I think a lot of the competition is doing exactly the same thing. We see people supporting their lead bank relationships and moving away from more speculative future opportunities.
spk12: Thank you. Can you just provide a little bit more color maybe on the deposit repricing and migration and how you see it playing out with higher for longer rates just impacting the deposit pricing pressures?
spk02: Yeah, I'll go ahead and handle that. I mean, I'd say first off, I mean, I think when you look at our performance from a deposit data standpoint, we feel like we're basically in the pack with what you're seeing across the industry, which is a really positive result compared to where we were last cycle. It's just part of the ongoing investments we've been making. in primacy and product capabilities and delivering the entire bank for our customers. So we're really kind of pleased to see how things are playing out cycle to date. That said, we still are, and frankly, when you look at the overall metric of non-interest bearing to overall deposits, we're around 22%. That's basically back to where we were pre-pandemic. We've seen a decelerating migration out of non-interest bearing into interest bearing. and seeing decelerating migration even inside of the interest-bearing book. Nevertheless, it's getting smaller every quarter. We would expect to see that really dissipating over the coming quarter or two. That's really what you see when you get late in the cycle and the Fed's on hold. Feeling very good about that trajectory.
spk04: Maybe, Brendan, do you track very carefully how we're doing versus peers and some of our strategies to continue to maintain that low-cost focus so maybe you could add some additional color?
spk03: Yeah, sounds good. So much of our low-cost deposit book is in the consumer space and obviously was buoyed through the pandemic by all the stimulus issues. We saw the rundown of the stimulus rate peak in May, and it started to abate as we got into the summer and the fall, although it's still kind of spending down at a decent clip. We do have a lot of analytics, benchmarking analytics on how we're doing, and this is supportive of John's commentary that the franchise is performing today. at a very different level than it did the last upgrade cycle. We believe we're number two in the peer set in terms of DDA consumer migration, so we're performing exceptionally well on the DDA side. When you look at beta on the consumer side as compared with the growth that we're getting, it appeared for about 400 to 500 basis points better in net growth on the consumer book through the cycle so far, and our betas are mildly better. So more growth, slightly better cost on the core book. That's excluding citizens' access. That's a real indicator of the quality of the franchise and the quality of the customer base that we've moved from sort of a community banking, high-priced, deposit focus to deeply engaged primary banking relationships. So, you know, we expect the pay down of low-cost deposits to continue to slow, obviously dependent on rate environment in the economy that potentially could change. What I do feel really confident in is that our relative performance to peers will be strong and will continue to outperform form on the consumer side, on the stability of our low-cost book. At the individual customer level, they still have a little bit more liquidity in their balances than they did pre-pandemic. That's largely held by affluent and high-net-worth individuals. Our mass market book, and even in the mass affluent space, they've sort of moderated back down to operating floors. So I think those are all signs that would support a continued slowdown in the rundown of low-cost deposits pending any recessionary impact that may bring them below operating floors. So we feel pretty good. And just on the uninsured and insured deposit front, you know, we saw a little bit of a blip on the uninsured in March. And since March, that has been incredibly stable and all parts of the book have been growing. So all the fundamentals point to continued trajectory of stability and certainly continued outperform. And then in addition to that, you know, we're controlling what we can control is We're performing in the top quartile in the United States in terms of household acquisition growth. The New York market, as John pointed out, is helping to give us an extra lever to drive low-cost deposit growth over and above just the portfolio trends, which are generally outperforming. So we do believe we've got a distinctive amount of levers for the franchise to continue to outperform in the medium-term outlook on low-cost deposits.
spk12: Very helpful. And then just one quick housekeeping. I just want to confirm, John, You said that the expense outlook for next year being flat, that includes the private bank build-out expenses?
spk02: Yeah, it does. Underlying expenses should be flat next year, including the private bank as well as non-core.
spk09: Got it. Thank you. Your next question comes from the line of Ken Usden from Jefferies. Please go ahead.
spk10: Hey, thanks. Good morning. Just a follow up on that last question. John, I just wanted to ask you, I know that the private bank bill that was $35 million of cost this quarter. Just wondering if there's any changes to your expectation of what that would trend like going forward as part of that cost commentary?
spk02: I think Brandon will probably have some color on this, but it's pretty similar into the fourth quarter. And then, of course, in the next year, you see it starting to migrate towards a, instead of being an EPS drag, it gets back to break even. when you get out into 2024, and then more broadly, a 5% contribution to EPS is our outlook there, but go ahead.
spk03: Yeah, there'll be into Q4 some very modest upticks, you know, in the low 40s potentially, and The reasons for that, we hired the majority of the team, as you all know, in the early part of the summer. The influences on that nudging up is our successful securing of various different private banking offices coast to coast to house the team and start to bring in customers into the platform, some operating expenses clients come on board, as well as we're playing some very selective second-tier offense. There's still a lot of talent in motion, and This quarter, after the first 150, we also hired another 25 really top A-list talent folks in all of those same offices that we opened in the summer. And so we're going to be selective, but as we see the right talent pop up, we're going to grab them. grab them and add them to the team.
spk04: The other thing, just in the way that COP is structured, Ken, that the folks who came over are on guarantees as if they're fully producing. So as the revenues come in, there won't be incremental costs. They'll just be kind of earning those pay levels. So another factor to consider.
spk10: Yeah, that's a great point. And then as a follow-up, you guys have done a great job over the years on the top program And I take your commentary about holding costs flat inclusive of these extra builds. That would imply a real turn exiting the year, given that you're ramped through the year on costs this year. And John, I know you mentioned AI as a piece of that increment, but you've done 100 plus of top each year. I'm just wondering, where else would you be digging in across the organization to get that magnitude of what seems to be a pretty meaningful implied extra cost savings? out of the numbers next year. Thanks, guys.
spk04: So it's Bruce, and let me start off, and then John can amplify. But, you know, the top program, I think, has been a real consistent contributor to our ability to deliver positive operating leverage. But to actually get to flat for next year, we have to go beyond that. So we've geared up a very nice top program and we're adding to it. But I think we're going to have to look at employment levels broadly to see where we can extract some folks. And we'll look at certain business activities that may be less important going forward than what we have been engaged in historically. We've already done some of that this year. So we've downsized the mortgage business quite a bit. We've exited the auto business So I think it's a combination of actions that's continuing to find ways to upsize top, leverage things like AI where we can do that, look at our overall org structure and staffing levels and see if we can pinch some efficiencies there, and then look hard at our business mix and figure out where the key here is, you know, not to just have a knee-jerk revenue. There's revenue pressure in the environment, so let's really take a hard knife at all expenses. We have to be judicious about where we're cutting and protect the things that we feel are really going to help us grow and outperform in the medium term. So things like the private banks, things like the New York Metro expansion, there's things that we're going to ring fence, and then there's other areas we're going to have to go a little harder with the knife. John?
spk02: Yeah, I think that covered it well, Bruce. And just ongoing fundamentals are bread and butter of focusing on organizational-related items and third-party spend and the like. And I won't repeat all the categories that Bruce articulated, but we've got a fundamental underpinning that we feel like we have the opportunity to broaden out with while protecting the initiatives that are going to help us outperform over the medium term.
spk10: Okay, got it. Thank you for the comment.
spk09: Your next question comes from the line of Manan Gosalia from Morgan Stanley.
spk07: Please go ahead. Hey, good morning. You have 67% of deposits from consumer, so a strong franchise there, and you noted that you should outperform peers on a relative basis. But one of your large peers noted last week that banks may still be over-earning on NII So I guess my question was, how do you see competitive factors playing out for consumer deposits next year, especially if the rate environment stays higher for longer?
spk03: Brandon, do you want to? Yeah, we certainly have seen continued heavy competition for consumer deposits. You're seeing kind of money market and CD rates in the mid fives in some spots. We feel like we're competing really, really well on that. Obviously, it's supported by our transformation on low cost. That's where you kind of start on how you manage strong NII levels and NIM levels is having a solid foundation of low cost, highly engaged customers. We have probably more levers than others have to manage through whatever the competitive intensity ends up coming our way in 2024. Certainly, we have citizens access, which has been an incredibly positive tool for us to grow interest-bearing deposits. in a smart way with really sticky relationships, but also it helps not put too much contagion into the retail banking system with heavy kind of window rates on the front of the branches that may drive in hot money and bring the franchise into non-relationship-based banking. And so that's been an incredibly effective tool to both raise money and also protect how we manage and compete on interest-bearing costs. We've also, where we have competed in In the core franchise, with some of the more aggressive rates, we've done it in an incredibly relationship-based way. So the access into, no pun intended with Citizens Access, access into higher rates on deposits, if you're a core banking customer of ours, requires you to be in a relationship product. We call it Quest or Private Client, which is a massive fluent or affluent value proposition. So when you do more with us, you get more. That strategy has enabled us to be more targeted in how we think about introducing interest-bearing costs into the environment that we're able to protect and retain balances in a really thoughtful way versus reprice the entire book in some spots. So it's intense out there. We expect that to continue through the first half of the year as deposits are sort of hard to come by through the U.S. banking system. But we think we've got the right tools and the right levers to continue to win and compete well with our peers.
spk02: Maybe just to add, it's all great points there, and just to add one other point about this, I mean, the rate environment is expected to become more constructive, I guess, is the point, meaning if you're raising deposits in a world where the yield curve is inverted – or at best getting less inverted, that's always going to be a tricky situation for banks until it becomes a more stable upward sloping situation, which I think is a little more likely to be the case as you get into 24 and certainly to the end of 24. when you start seeing lower short-term rates and, nevertheless, an attractive long-term rate where we can basically deploy our capital and make a positive return. So that's really what I think is going to shake out as you get into 2024.
spk04: One last piece of color I would add is that as we enter 2024, we're still kind of having a net loan shrink, and that'll eventually turn around as the private bank starts to put on loans, and we'll see where the economy is. But we won't really need to – we're not pressured to grow deposits given that dynamic on loans. We can still see the LDR improve just by keeping drop a little bit. So factoring that into the calculus of do you really need to be aggressive given that's your dynamic around loans and deposits that helps you manage the cost of your deposit franchise.
spk07: Great. Thank you. I appreciate all the color there. And just separately on the LCR requirements, you mentioned that you're compliant in both Category 1 and Category 3 now. and that this bill is also NII neutral. But I guess the question is, how much more do you think you need to build from here? And how do you think about that increasing your asset sensitivity in the long run?
spk02: Yeah, I mean, I basically say a couple of questions in there. I mean, I think the The regulatory requirements are generally inducing banks to become more asset-sensitive. You've got the issue of, more broadly, if the long-term debt rule goes in, that would be along with having to hold – liquidity that is shorter duration, that's going to, you know, cause asset sensitivity to grow over time. We're naturally an asset-sensitive bank, and those forces would cause us to be more asset-sensitive, so that'll, you know, we'll have to consider in the coming, during the transition periods, whether it makes sense to moderate those positions without balance sheet types of actions. But nevertheless, there's generally a tailwind of asset sensitivity in being created from the regulatory environment, but also idiosyncratic to us, our non-core portfolio, if that runs off, that's mostly a fixed book, and that has a tailwind to asset sensitivity. We're around neutral now, so becoming a bit more asset sensitive over time is some of the underlying forces there that I would say are in place, and we'll decide as the environment plays out how and whether to to moderate that. And, again, the liquidity build is NAI neutral, so it's really not a driver. And it's something that, you know, again, the NAI guide of down 2% is really driven by, you know, basically having the X liquidity build, NIM decline is really the driver of that, and it equates to the 2% that you're seeing in the guide. So that's the way to pull it all together for 4Q.
spk09: Great. Thank you. Your next question comes from the line of Matt Connor from Deutsche Bank.
spk11: Please go ahead. Good morning. I want to talk earlier in the call in terms of the interest income trajectory for next year and all the puts and takes. But I just wanted to circle back on that. In a stable rate environment, so kind of higher for longer, when and around what level does the interest income dollars start to bottom?
spk02: Yeah, I mean, you know, we're still working through our 2024 outlooks, right? So we're going to be, you know, much more, I would say, transparent about what our expectations are for 2024 as you get into planning season here and completing that. And, of course, we do that in January. You know, with that said, we, you know, broadly, you know, as you look at the swap trajectory for us into 2024, we have a swap portfolio growing. right around the time that the forwards would indicate the Fed would begin to cut. As a matter of fact, as I mentioned earlier, you could actually see deviation around that, and we happen to have a view that it's likely that it will actually come in a little lower than where the forwards have it coming in at the end of 2024. So that will be a mitigant. And as I mentioned, the non-core rundown is a mitigant. And, you know, private bank, as that grows, is, of course, accretive. The other thing I'll mention, I mean, if you get beyond 24, and you look at what's happening in the 25 through 27 timeframes, it's certainly more consistent with a more neutral Fed posture. That would represent, regardless of what the transition is in 24, that would represent a significant tailwind getting into 25 through 27 as you see the swap portfolio being more of a neutral impact to net interest margin and NII. And so working our way through 24, we get some really nice tailwinds. And that's just on the active swap portfolio. We also have a locked in and baked in tailwind from the terminated swaps, which run off. as you can see on our slide, in a significant way over 25 to 27. So I would call 24 a transition year while the Fed normalizes rates and our balance sheet optimization takes hold with non-core and creates a lot of momentum as you look out into 25 and beyond.
spk04: Yeah, I would just add a little color here, Matt, to you and Erica's question. I think Erica was looking for John to say, you know, are you still holding at 3%, you know, in the fourth quarter this year and the fourth quarter next year. I think the reluctance to draw a line in the sand on 3% is the amount of the liquidity build and that, you know, some of the cards from the regulators on new liquidity regulation aren't turned over yet. So just putting that aside, if you just say that's a bit of an unknown, Do we still have an ambition to have our exit rate at the end of 23 be roughly the exit rate at the end of 24? Yeah, that would still be the ambition. We have to go through the work, as John said, to go through kind of the budget process for next year, but that's still where we'd be hoping to arrive.
spk11: And then just in terms of the impact of rate cuts versus higher for longer scenario, what does higher for longer do versus the rate cuts? Because it sounds like you're still a little asset sensitive, but the roll-on of the swaps would obviously benefit from rate cuts. So what's the net impact if rates are stable versus what the forward curve has for next year? Is it better or worse?
spk02: I'd say that where we're positioned, we're right around neutral. A small increase in rates is actually positive to our platform. We tend to calculate this stuff using the 100 basis point and 200 basis point gradual rises. We're relatively neutral in those kinds of calculations, which you'll see disclosures on in our 10Q. But when it comes to just another hike and those kinds of conversations, meaning we tend to, in those environments, continue to make money and have a positive impact to NII. Generally, the forward curve is favorable to us. I think we like the tracking of the forward curve. We start getting cuts at the end of 24, and that allows the continued front book, back book. We like the long end being more anchored, a little higher. That helps, too, in terms of our originations of our fixed rate loan book. So, again, and it also provides opportunities to later on lock in higher rates to the extent that that's desirable. So, you know, the forward curve is, I think, constructive for us. Sloss or minus is fine. I think large moves either way is where we would say it starts to, you know, kind of create, you know, potential headwinds. But other than that, we're feeling – we would feel okay with it.
spk11: Okay. So to summarize, steeper is better as a good rule of thumb.
spk02: I'd say a forward curve is better and plus or minus is not going to move the needle very much. So having some cuts at a slow – I mean, in general, over the long term, banks do better. We're a maturity intermediary. when we have an upward-sloping yield curve. So the short rates are at 550. We think that it's more constructive to see short rates around 3 to 350 over the long term. We also think it's constructive to have a 10-year that's north of 4% in that same environment. So therefore, a gradual decline from 550 down to about 3 to 350 over the next two years, we think is not only good for us but good for the industry and allow us to get back to an upward-sloping yield curve. And I think that that's the environment where we would be performing in a very good way. That said, we pivot and manage to the extent that the rate environment migrates differently than that, but that's the one that I would say works out the best for us and the industry as a whole.
spk09: Okay, that sounds, thank you. Your next question comes from the line of Vivek Duneja from JPMorgan. Please go ahead.
spk06: Hi, thanks. I guess I have a couple of clarifications given all the discussions going on. John, when you said, let's start with expenses, you talked about underlying expenses to be flat next year, but then you also said that includes private bank and non-core. non-core is not included in the way you define underlying expenses. So are you saying both underlying, which is core, and reported expenses are both going to be flat next year?
spk02: Now, say underlying expenses at the top of the house will be flat next year, 24 versus 23. Underlying includes private bank. It includes non-core. Overall CFG expenses will be flat at 24 versus 23.
spk04: Underlying does not exclude those things today, Vivek. It includes those things.
spk06: Okay. So I want to – all these definitions, everybody has a little difference, so it's important to clarify that. Thank you. The second one, I guess, John, going back to the rate discussion, to get my head wrapped around that, if I heard you right just in response to Matt's question, it's that small increase in rates is beneficial to NII, but then rate cuts is also positive. So I'm trying to reconcile how both scenarios are positive for you. Yeah, I can...
spk02: Yeah, I can clarify that, Vivek. I mean, a small increase in rates from here would drive some NII, a small amount of NII. And a small decline would be a small negative in terms of a small decline in NAI. But they're both quite small, which is why we're calling ourselves neutral. But from a positioning standpoint, it would be a small positive if rates rose from here. And, you know, let's say one additional hike, for example. Let's say that if the Fed has a hike in the fourth quarter in November or December, we'll see an NAI contribution to that. A small cut goes the other way, but not a significant decline if there was a cut. Thank you. Yeah, and to be clear, the difference here is what happens immediately, say in the next quarter, versus what happens over time. We are very constructive and feel very good about a gradual decline in rates, where the short end gets down to three to three and a half over, you know, call it, you know, a orderly period of time. We think that's very good and it gives time for balance sheets to adjust and to have front book, back books continue to get locked in and be supportive of a healthy balance sheet migration over the next, you know, call it a year or two as our balance sheet optimization continues to take hold with non-core runoff, et cetera. So we would – our balance sheet does well with an upward-sloping balance sheet that we'll migrate to over the – you call it the 24 and early 25 period.
spk06: And one more clarification that's helpful on the expenses. Bruce, when you talk about stable for next year, what are you assuming for capital markets? revenues and therefore incentive comp goes up, or are you just using current level? Any color on that?
spk04: Yeah, well, we haven't given the full guidance yet on 24, but there is a variable element of pay that if revenues go up in capital markets, that pay would go up. That's probably the one area that has the greatest tie to revenues across the bank. and we would have to contemplate that as we go through the budget process. So we said we're targeting the flat expenses for next year, and we would incorporate our view on kind of where the capital markets fees are going to be and then what additional payouts would result from that, and then we'd have to find ways to offset that elsewhere in the bank.
spk06: Thanks.
spk09: And at this time, there are no further questions. With that, I'll turn the call over to Mr. Van Zandt for closing remarks.
spk04: Okay. Thanks again for dialing in today. We certainly appreciate your interest and support. Have a great day. Thank you very much.
spk09: Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect.
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