Citizens Financial Group Inc
NYSE:CFG
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Citizens Financial Group Inc
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Good morning, everyone, and welcome to the Citizens Financial Group Second Quarter 2022 Earnings Conference Call. My name is Alan, 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 Kristin Silberberg, Executive Vice President, Investor Relations. Kristin, you may begin.
Thank you, Alan. Good morning, everyone, and thank you for joining us. First, this morning, our Chairman and CEO, Bruce Van Saun; and CFO, John Woods, will provide an overview of our second quarter results. Brendan Coughlin, Head of Consumer Banking; and Don McCree, Head of Commercial Banking, are also here to provide additional color. We will be referencing our second 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 2 of the presentation. We also reference 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 Bruce.
Thanks, Kristin, and good morning, everyone. Thanks for joining our call today. There was a lot going on in Q2 with a focus on closing the Investors acquisition and commencing our New York City Metro integration efforts. In addition, the Fed's move to rein in inflation through higher short rates and quantitative tightening put a spotlight on a joint management of our capital, liquidity and funding position as well as our interest rate management. The good news is that we made strong progress on all fronts while posting very good financial results.
Our underlying EPS for the quarter was $1.14, that's up 7% from the first quarter and ROTCE was 15.5%. Positive sequential operating leverage was 11.7% on an underlying basis, and that's 6.3%, excluding the impact of acquisitions, our PPNR growth was 45%.
Driving these strong results was a significant sequential jump in net interest income of 31%. That's 9% ex-acquisitions as spot loan growth reached 19%, which is 4% ex-acquisitions, and our net interest margin jumped 29 basis points. We are seeing a strong pickup in line utilization in commercial which has afforded us the opportunity to be more selective in lower returning consumer portfolios like mortgage and auto.
Our deposit performance was good as period-end deposits, ex-acquisitions, were up 1%. Our fees were relatively resilient, up 2% ex-acquisitions, given the diversity of our fee revenue streams. Higher volatility kept capital markets in check though it benefited FX and derivative product revenue, which hit an all-time high. Wealth continued to grow nicely in the quarter, while mortgage revenue was up slightly. We did our usual fine job on expenses and credit performance continues to be excellent. We continue to see favorable trends in key credit metrics on both the commercial and consumer side. At this point, we feel the second half should hold up well with only gradual normalization in loss rates given the solid positioning of our customers today.
We currently expect our solid momentum to continue into the second half of 2022. We will continue to benefit from rate rises. Our fees should remain resilient, and we will benefit on expenses from our acquisition synergies and the TOP 7 program. We project positive operating leverage in Q3 and Q4 with ROTCE moving beyond our 14% to 16% target range.
The market seems concerned about the rising possibility of a recession in 2023 and the potential for much higher credit costs. At this point, we see slower economic growth as the base assumption for 2023 and if there is a recession, we believe it should be shallow and short-lived. We are being highly selective on new loan originations, and we've moved several portfolios to held for sale, largely from investors to optimize our balance sheet position.
We continue to believe our credit performance will be good on a relative basis, should a downturn come. It's an exciting time for Citizens. We have many promising initiatives in flight that we are managing well. We are focusing on areas where we can leverage our strengths and where we have a right to win. The current environment gives us a great opportunity to prove our mettle and deliver prudent, sustainable growth. We certainly feel up to the challenge.
With that, let me turn it over to John to cover the financials in more detail. John?
Thanks, Bruce. Good morning, everyone. First, I'll start with our headlines for the quarter, referencing slides four and five. We reported underlying net income of $595 million and EPS of $1.14. Our underlying ROTCE for the quarter was 15.5%. Net interest income was up 31% linked quarter driven by a 29-basis point improvement in margin and strong loan growth, including the impact of the HSBC and ISBC transactions.
Period-end loans were up 19% linked quarter. Excluding loans added by the HSBC and ISCC transactions, loan growth was a strong 4% led by commercial growth of 6%. Average loans are up 19% linked quarter, excluding the acquisitions, average loans were up 3% with 5% growth in commercial. Underlying fees were up 5% linked quarter or 2% excluding HSBC and ISBC acquisition impacts, reflecting the diversity and resiliency of our fee businesses.
Our client hedging business had another exceptional quarter, and we delivered record results in Wealth and Card. Mortgage fees were up slightly and capital market fees were down a bit, given continued market volatility. We remain disciplined on expenses which were up 1% linked quarter, excluding the HSBC and ISBC transactions.
Overall, we delivered underlying positive operating leverage of 11.7% linked quarter and that was 6.3%, excluding the HSBC and ISBC transactions. Our underlying efficiency ratio improved to 58%. We recorded an underlying provision for credit losses, excluding ISBC of $71 million, which reflects continued strong credit performance across the retail and commercial portfolios.
The underlying credit provision for the quarter excludes $145 million for the double count of CECL provision expense tied to the ISBC transaction. Our ACL ratio stands at 1.37% down from 1.43% at the end of the first quarter. Our tangible book value per share was down 6% linked quarter, driven primarily by the impact of rising rates on securities and hedge valuations that impact AOCI.
We continue to have a very strong capital position with CET1 at 9.6%, and we have increased our common dividend by 8% to $0.42 a share.
On Slide 5, we have provided the HSBC and ISBC contributions to our second quarter results as well as the notable items for the quarter. Also, Slide 21 in the appendix provides a summary of the purchase accounting impacts associated with the ISBC transaction.
Next, I'll provide some key takeaways for our second quarter results. On Slide 6, net interest income was up 31%, given higher net interest margin and 17% growth in interest-earning assets, including the impact of the HSBC and ISBC transactions. The net interest margin is 3.04%, up 29 basis points, which as you can see on the NIM walk in the bottom left-hand side of the slide shows the benefit of higher rates with a 24 basis point increase related to asset yields reflecting the asset sensitivity of our balance sheet and improved securities reinvestment rates.
There is an 11 basis point benefit from the HSBC and ISBC transactions, largely given the repositioning of the ISBC securities portfolio and the benefit of adding their loans. With rising rates, funding costs reduced the margin 8 basis points, reflecting well-controlled deposit costs. Earning asset yields are up 38 basis points linked quarter, strongly outpacing our interest-bearing deposit costs, which are up only 8 basis points.
Moving to Slide 7. Given the Fed's recent rate hikes and the current market expectation for the Fed funds rate to end the year in the 350 to 375 basis points range, we are confident that we will continue to realize meaningful benefits from rising rates as the forward curve plays out. Our asset sensitivity has driven a significant improvement in NII in the first half of this year, and those benefits will continue to accumulate in the second half of 2022 and compound into 2023.
Since the path of the rate cycle is uncertain, on the top left side of this page, we've provided an estimate of our NII sensitivity to further changes in rates, either up or down from the June 24 forward curve. Our overall asset sensitivity stands at about 2.5% at the end of the second quarter. This is down from 7% for the first quarter, reflecting the incorporation of ISBC's NII base and liability-sensitive profile as well as hedging actions taken to stabilize the margin and protect against downside interest rate risks.
Our improved NII outlook as well as changes in the balance sheet also contributed to the reduction in asset sensitivity. Essentially, a 25 basis point instantaneous change in the forward curve is worth about $10 million to $15 million a quarter with that balance between the long and short parts of the curve. We began the rate cycle with a strong liquidity profile, deposit costs as low as they have ever been, and our overall funding profile greatly improved, including significant improvements to our deposit mix and capabilities.
We will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits. So far this cycle, with Fed funds increasing 150 basis points since the fourth quarter of 2021, we are quite pleased with how our deposit franchise is performing with a cumulative beta of about 6%. On a sequential basis for the second quarter, our beta was 11%. This puts us on track for a 35% cumulative beta through the end of this rate cycle if the forward curve plays out as expected.
Moving on to Slide 8. We posted solid results, demonstrating the strength and diversity of our fee businesses. Capital Markets delivered solid results despite continued market volatility impacting the bond and equity markets. We saw M&A advisory and equity underwriting fees picking up a bit, but these were more than offset by modestly lower loan syndication revenue. We continue to see good strength in our pipelines and capital markets fees could rebound nicely in the second half of the year if markets settle down, and there is more certainty regarding the path of the economy.
We once again delivered a record performance in our client hedging business, up $9 million linked quarter, driven primarily by FX as we help clients manage their currency exposures as the dollar strengthened during the quarter.
Our interest rate and commodities businesses also performed very well, but were down modestly from record levels in the first quarter. Mortgage fees were up modestly linked quarter given improved servicing income as higher mortgage rates resulted in slower amortization of the MSR.
Production fees remained under pressure given lower industry origination volumes with rising rates and seasonal impacts. Strong competition continues to pressure margins. However, there are clear signs that the industry is beginning to reduce capacity, which should benefit margins as we head into the second half of the year.
We delivered record wealth fees, up 8% linked quarter as rising market interest rates supported customer flows into annuity products. Card fees were also a record given seasonally higher transaction volumes.
On slide nine, expenses were well controlled, up 1% linked quarter, excluding HSBC and ISBC. Our TOP 7 efficiency program is continuing to make good progress, on track to deliver $100 million of pretax run rate benefits by the end of the year.
Period end loans on slide 10 were up 19% linked quarter, primarily driven by the impact of the ISBC transaction, which closed at the beginning of the quarter. Excluding the impact of the HSBC and ISBC transactions, loan growth was 4% with strong commercial loan growth again this quarter, up 6%, led by C&I as we emphasize strong relationships to optimize risk-adjusted returns.
Retail loans were up 1% as we continue to be more selective in consumer lending. Average loans were up 19% linked quarter or 3% excluding the impact of the HSBC and ISBC transactions with 5% growth in commercial led by C&I and 1% growth in retail.
In commercial, we continue to see strength in corporate banking originations across every region. Line utilization continued to rebound with an increase of about 300 basis points to 39% on a spot basis, primarily driven by corporate banking with the largest quarterly increase in utilization we have seen since early in the pandemic.
Our clients are continuing to use their lines to build inventories to get ahead of supply chain issues and rising input prices and some are also looking to pro rata bank financing as an alternative to the volatile bond markets.
Comparing with the ISBC acquisition, we identified certain non-strategic loan portfolio totaling $2.1 billion, which we are in the process of being marketed for sale. These loans were classified as held for sale at quarter end. This will free up capital and enable our relationship bankers to focus on more desirable commercial relationship business in New York Metro.
On slide 11, our period-end deposits were up 13% linked quarter as we added $19.8 billion of deposits from the ISBC transaction. Excluding ISBC and HSBC, period-end deposits were up slightly, while average deposits were down slightly, reflecting seasonal runoff on a decline in commercial surge deposits.
Moving on to slide 12. We saw excellent credit results again this quarter across the retail and commercial portfolios. Net charge-offs were at 13 basis points, down six basis points linked quarter. Non-performing loans fell six basis points to 54 basis points of total loans linked quarter, driven by improvements in C&I, residential real estate, and home equity.
Other credit metrics continued to look excellent across the retail and commercial portfolios and criticized loans as a percentage of the commercial portfolio are stable after incorporating ISBC, but down on a standalone basis.
On Slide 13, I'll walk through the drivers of the allowance this quarter. We continue to see excellent credit performance across the retail and commercial portfolios. We added to the reserve this quarter to take into account strong commercial loan growth as well as the addition of ISBC. While we aren't seeing any signs of early stress in the portfolio at this point, our allowance takes into account the expectation of a more challenging macroeconomic outlook, given the Fed's rate actions to combat inflation.
Our overall coverage ratio was 1.37%, which is a modest decline from the first quarter, reflecting the strong performance of our retail portfolio and the addition of the ISBC's CRE portfolio, which includes a sizable multi-family component with lower reserve requirements than our legacy portfolios. If you recall, when we adopted CECL at the beginning of 2020, our coverage ratio was 1.47%. To put our current coverage ratio in context, we estimate our pro forma coverage ratio would be slightly lower than the 1.37% level today if we applied our current portfolio mix, incorporating ISBC to our day one CECL approach.
Importantly, our coverage of non-accrual loans strengthened 256%, up from 238% in the first quarter. We feel good about the improvements to the loan portfolio we've made over the past few years and the overall positioning of our credit risk.
Moving to Slide 14. We maintained excellent balance sheet strength. Our CET1 ratio remained strong at 9.6%. Following the release of the Fed's DFAST stress results last month, our Board increased our common share repurchase authorization to $1 billion. And today, we announced an 8% increase in our common dividend to $0.42 a share. Our fundamental priorities for deploying capital have not changed, and you can expect us to remain extremely disciplined in how we manage the company.
Shifting gears a bit. On Slide 15, you'll see some examples of the progress we made against the key strategic initiatives and other work we are doing across the bank to better serve our customers and make Citizens a great place to work. As you know, we closed the acquisition of ISBC at the beginning of April, and we are very focused on a successful integration.
I am proud of the work our teams have done related to the acquisition. We onboarded more than 1,600 new colleagues through our HR systems on day one, and in the second quarter, we began originating mortgages on our systems. We have a number of conversions planned over the remainder of the year, and we are on track to finish in the first quarter of 2023.
We have included a high-level integration time line in the appendix on Slide 22. Importantly, we are on target to achieve $130 million in run rate net expense synergies by the end of 2023, of which approximately 70% will be achieved by year-end 2022. The total represents about 30% of ISBC's 2021 expense base.
Also, ISBC integration costs to be incurred through 2023 are now expected to come in below the estimated level of deal that you announced. We recently released our fifth annual corporate responsibility report, which highlights our progress on ESG initiatives. The report highlights a number of significant milestones related to our sustainability efforts, including our progress towards targets to reduce greenhouse gas emissions.
We also announced that we've joined the Partnership for Carbon Accounting Financials, which will accelerate our efforts to measure and disclose finance emissions. Later this year, we'll release our first TCFD climate report, which will describe our climate strategy in more detail. The report also describes our commitment to the communities we serve, and there are a few recent examples here on the slide with some of the community partnerships we are engaged with in Boston and most recently in Chinatown and Queens, New York.
On the consumer side, we are excited about continuing our expansion in Florida with the opening of our latest Wealth Center in Naples. We recently released a mobile app version of Citizens Access, which we think will be very popular with our customers. And we are very proud that our Citizens Pay point-of-sale offering was awarded Best Innovation by the Banking Tech Awards. Lastly, our relentless focus on customer service, driving results as our ATM channel moved up eight places in the J.D. Power rankings.
On the commercial side, we continue to perform well in the league tables, consistently ranking in the top 10 as a middle market and sponsor book runner. The diversification in our business model is delivering results with record revenue in our client FX hedging business. We also closed the DH Capital acquisition this quarter, strengthening our capabilities in the Internet infrastructure, software and next-generation IT services and communications sectors.
On the right side of the page, we've included some digital metrics. Mobile active users are up over 20% year-over-year. Digital deposits and Zelle transactions are up over 30%, and we are seeing great success with the customer uptake of automated client service through virtual chat sessions. We are very excited with how our digital first approach is increasing engagement with our customers and how this is all translating into a better experience and higher satisfaction.
Moving to Slide 16. I'll walk through the outlook for the third quarter. Since we closed ISBC at the beginning of the second quarter, our third quarter outlook includes all our recent acquisitions. We expect NII to be up 5.5% to 7%, driven by the benefit of higher rates and solid loan growth. We are very focused on optimizing capital deployment.
In consumer, we will reduce originations in mortgage, auto and education refi, while seeking to grow in home equity, in school education and Citizens Pay and Card. In commercial, we expect to see further increases in-line utilization, but we'll be mindful of balancing growth and returns given current macro uncertainty. These are expected to be broadly stable though upside exists, if capital markets stabilize.
Noninterest expense is expected to be up approximately 1%. We expect to continue strong sequential positive operating leverage in the third quarter and ROTCE above our medium target range of 14% to 16%. Net charge-offs are expected to be approximately 20 basis points. We expect our CET1 ratio to land around the midpoint of our operating range at 9.75%. And our tax rate should come in a bit lower at approximately 22%.
With respect to full year results, we expect PPNR to be in-line with our April guidance. From a revenue standpoint, we are seeing higher NII given net interest margin, reaching approximately 3.25% in the fourth quarter, driven by higher rates and loan growth within our 20% to 22% guidance range. This will be offset by lower key revenue largely in capital markets and mortgage.
Expenses will be well controlled, which will result in full year operating leverage of at least 400 basis points and a fourth quarter efficiency ratio of sub-55%. We also expect the net charge-off ratio to come in lower than we guided in April, given continued favorable trends.
To sum up on Slide 17. This was a very solid quarter and we are optimistic about the outlook for the rest of 2022 and beyond. We are off to a running start in New York with the close of our two acquisitions there, and we expect significant benefits in our net interest income from the higher rate environment and strong and commercial loan growth. The strength and diversity of our fee business is driving solid results and our capital markets business, in particular is well positioned for when markets stabilize given strong pipelines. We will continue to focus on executing against our strategic priorities and building a top-performing bank that delivers for all our stakeholders.
With that, I'll hand it back over to Bruce.
Okay. Thank you, John. Operator, let's open it up for Q&A.
Thank you, Mr. Van Saun. We are now ready for the Q&A portion of the call. [Operator Instructions] Your first question will come from the line of John Pancari with Evercore. Go ahead please.
Good morning.
Hi, there.
Good morning.
Just on the loan front, I guess it's also a credit question. I know you indicated that you're being more selective in select areas of consumer lending. Can you maybe give some color there in terms of what areas are you becoming more selective, what you're seeing that's making you become more selective, or is it just actually the broader backdrop? And what that could mean for growth in the consumer portfolios? Thanks.
Yeah. Well, let me start, and then I'll go to Brendan and then John, I'm sure might want to chime in. But I think we have the potential to continue to grow in consumer maybe at a faster pace than would be ideal in the current environment. So we're seeing a lot of growth right now on the commercial side line utilization picking up. And I think in light of the environment that we're seeing out there and transitioning in the investors' balance sheet, just making sure we're focusing on allocation of capital to the highest and best uses and not putting a strain on deposit growth as we're going through this higher rate environment is the game plan at this point.
So when we look into the consumer world, clearly, mortgages and auto are areas where we've seen a lot of growth over the past couple of years. We're going to basically put mortgage more on a stable path and start to reduce our originations in auto. Those are really return costs. It's a return on capital cost where we think we have opportunities to grow in areas that deliver better returns would be things like HELOC, like the in-school student and then also card and Citizens Pay. So I think overall, we'll still see some net modest growth, but we're going to take some pluses and some minuses here and really be focused on capital allocation. So with that, Brendan, do you want to add to that?
Yeah. I guess just strategically, what I'd add is I think this is a natural pivot point for the journey of our strategy. We're at the early stages of our IPO, everything was accretive for the most part. And so we've really scaled up our business. And I believe we have one of the most well run and diversified consumer lending franchises amongst our peer set for sure. And if we enter this next phase of our journey, capital allocation is king, and we're making some strategic pivots. I'd also say, this is not necessarily brand-new news. If you recall, prior to COVID, we had already started signaling we were going to start to put auto, as an example, on a path to reduce and get back into tier levels for concentration. And through COVID, we found some great vintages of returns and market disruption. So, the benefit of the diversity of our business model allowed us to flex up through COVID and now we're sort of returning to our original glide path down of auto, given that -- the auto business is naturally in sort of steady state, a lower return and less relationship focused.
And then to Bruce's point on mortgage, we've been outgrowing the Citizens balance sheet on mortgage growth for quite some time. And so we would like for that to grow no faster than the rate of the bank, just given where we're at right now on interest rates and a long duration nature of that business. And so really making sure we're protecting our balance sheet for long duration for real relationship focused lending and customers is key.
The other place we're curtailing a bit is some fintech partnerships that we've had over the years that served us well and added operating leverage allowed us to invest back in the bank, but being much more relationship focused and our capital allocation is king.
But we're very excited, as Bruce pointed, about a couple our places of our franchise. HELOC being one, where we believe we're the number one originator in the US for HELOC origination.
Credit quality is extremely good as super prime as it gets, 780 FICO, six year LTVs and we're poised to capitalize on that. And the in-school student product, as Bruce pointed out, is coming back strong as the effects of COVID wear off a little bit on student enrollment and then Citizens Pay, we do have aspirations for medium-term growth in that product. So, I think we're well-positioned. We can flex up. We're not taking down muscle mass, just making some capital allocation decisions as we optimize the balance sheet.
I think we said a lot, John, anything to add Okay. I think we're good.
All right. Thank you for that. And then just separately on credit again. Just I know you had indicated in your outlook that you do expect some economic slowing as you look into the rest of this year into 2023, but also that your reserve does consider a degree of that. How do you think about what you could potentially see to begin to build the reserve more meaningfully here? And if that does take hold, where do you think that reserve could traject over time? What do you think is a fair level given your economic outlook?
I'll kick off and hand it quickly to John. But one of the things we pointed out was that we're about where the day one reserve would have been had we incorporated Investors into those numbers. So, this 1.37 ratio. It's down from 1.47. But if you look at the shift in some of the asset composition, we're about at day one. And we have incorporated a Moody's scenario that does have a GDP slowdown and higher recession risk into that scenario.
So, I would say, absent a meaningful change in outlook that we could probably hang around this neighborhood for a while. So, anyway, that would be my top of the house view. But John, for more detail, please?
Yes, sure. I mean I think that's right. I mean I think our base scenario this quarter really relies predominantly on a mild recession, which would last into sort of into next year. So, I think we're covering that part of it. We even layered in certain aspects of the portfolio a more severe recession. That's also built into where we are.
And to Bruce's point, the mix shift in our portfolio has been extremely positive over the last couple of years. So, when you fast forward from the first quarter of 2020, the beginning of 2020 to the -- here in the second quarter of 2022, our mix profile is just much better. And so you can almost think about the fact that we're sort of back to the beginning where we have some uncertainty and some negative scenarios priced in. And without a significant deterioration in the macro as Bruce indicated, we're lucky to be in this range as you get into the end of the year.
And I think it makes sense. If you just step back and think about the consumers in really good shape, still has a lot of liquidity. Companies have refashioned their business models coming out of COVID. They're all in pretty good shape and contending with inflation and supply chain and trying to maintain their margins. So, historically, if you have a good jump-off point, you go through a shallow recession, bank charge-off rates don't go up all that much. So I think you'd have to see a meaningful change in outlook for us to come off that view.
Got it. All right. Thanks, Bruce. Thanks, John.
Your next question will come from Scott Siefers with Piper Sandler. Go ahead please.
Good morning guys. Thank you for taking the question. Maybe just some additional thoughts on how you see deposit cost pressures play out. I think we can get a pretty good sense from Slide 7, how you see the full year sort of trajecting and was glad to see you reiterate the 35% through the cycle beta expectation. But as we look through the remainder of the year, where specifically do you see the pressures that get you to the 25% to 30% by year-end. And then maybe if you can flesh out your thinking on deposit cost dynamics once the Fed stops raising rates?
Yes, I'll take that. I mean, I think the best way to describe that. I mean, we articulated that our cumulative beta 6% through the second quarter, better than we expected. So we're feeling good about where we're starting off this rate cycle.
Our outlook indicates a deposit beta getting into the 25% to 30% range by the end of the year, which implies the sequential betas in the second half in quarters being around mid-30s. So that's how that math would play out. So that's how that trajectory would work.
The drivers of that are predominantly on the commercial side of the business, but as expected, consumer and retail deposits are incredibly well performing and well behaved in terms of deposit betas, and we expect that to continue throughout the rest of the year.
We have a little bit of room on the balance sheet for Citizens Access. And all of that has been incorporated into our outlook for the 25% to 30% by the end of the year and for the approximate 35% through the whole cycle. Deposit betas will continue to rise as you get into 2023, and that's the difference between the approximate 35 and the 25 to 30 that we're talking about. And they tend to continue to rise when the Fed stops, assuming that the Fed doesn't start easing immediately thereafter, right?
So the last cycle, we had the Fed end of the cycle over the next quarter, we were easing. And so that sort of clipped off the lag effect that you would typically see in deposits. But if the Fed stops and stands at then you would see deposit costs continue to rise for another quarter or two after the last Fed hike. But I should hasten to add that that there's the loan beta side of this equation.
And the loan beta side of it is loan betas basically are rising, and they will continue to rise into the Fed tightening cycle and even after the Fed stops and our, in particular, all the tailwind from some of the term fixed lending that often really gain steam when you get to the end of the Fed tightening cycle, that's really what continues to drive net interest margin rising which we would say, would continue to rise throughout '23 even as the Fed continues to rise, given the fact that loan betas would exceed deposit betas.
Okay. Perfect. That's great color. And I guess along those lines of, sort of more all-encompassing rate sensitivity. So, I guess you're a little less asset sensitive now with ISBC in there. I think a couple of moving parts with the hedging. How would you say your overall rate sensitivity changes from here or is this sort of, kind of a good steady state for where we're at now?
Yes. Let me jump in. It's Bruce, and I'll give it back to John. But I think what we've tried to do, Scott, is find that sweet spot where we still have asset sensitivity sufficient to participate, if the Fed has to keep going beyond what's expected. But also, we like this level of NIM and this level of NII. And so, if in fact, a recession is in the offing and then rates turned down, we've locked in a fair amount of that NII for a good period of time. So just trying to get that balance right where we take away the downside and allow ourselves to continue to participate in the upside is, where we try to land it over the quarter. John?
Yes, I agree with that. And the – I guess the point is that, without management actions as you think about how the balance sheet unfolds from here. A big decline in the quarter really was just pulling in ISBC, just the base NII alone, reduces your assets – you just have a bigger base on that – from that percentage to be calculated. But so that was the source of the decline primarily and our management's actions. So, if you don't -- if you take away management's actions looking forward, actually, our asset sensitivity would tend to begin to rise again.
As mentioned earlier, the rotation out of consumer lending into a lot of the consumer commercial lending. And even within consumer lending, the fact that HELOC is a big driver, which is a floating rate product. You really are reestablishing asset sensitivity as things – as the balance sheet unfolds in the coming quarters, all of that is absent management's actions, right? And so, that's really going to tell the tale about where we land things.
If we get towards the end of the year, it -- and if rates are inflation still remains stubbornly high, that will tell us where we take the balance sheet under that scenario. If it feels like June was peak inflation, as you get to the end of the year, you would see us wanting to lock in a little bit more. So, we'll just see how it plays out. But naturally underpinning the balance sheet is some upward lift on asset sensitivity.
All right. Perfect. Kristin, John, thank you guys very much.
Sure.
Your next question will come from Peter Winter with Wedbush Securities. Go ahead.
Good morning. I just wanted to follow up on Scott's question regarding the deposits. But can you just talk about how you're thinking about deposit growth in the second half of this year versus the second quarter?
Yes. I think the -- you've got a big driver being commercial, right? And there's two drivers there. One is, the fact that there was some surge in the commercial business that has been running off. And frankly, most of that's been run off by the end of June. It's down to a relatively smaller level now and that was a driver -- also a driver is the natural seasonality of our deposit flows, which tends to have 2Q as one of the lower points during the year.
So, when you think about through the rest of the year, they'll be the broad continuing to execute against all the investments we've made over multiple years in driving consumer deposits and also the natural uplift and frankly, driving commercial as well. But the natural uplift at the second half tends to deliver in the commercial side of the business from a seasonality standpoint and lower drag from surge runoff. So that's how we see the second half playing out.
And how much is in...?
Yeah, just to make that clear. So the net would be -- we'd be expecting to resume growth in the second half. And I think that would be led by commercial growth, but consumer also would expect to see some growth as well.
And you gave some color on the moving parts on loans in the third quarter going to be led by commercial. But I'm just wondering if you could just be a little bit more specific on the type of growth rates you're expecting on commercial versus consumer and maybe line utilization in the third quarter?
Yeah. Well, I mean I think the -- in the second quarter, just talking about the jump off here, maybe helpful because in the second quarter, we had -- on the commercial side of the house, we had 5% average growth. But on a spot basis, we had 6% growth. So you can see that what that implies is that you're likely to see commercial be a big driver in the second quarter. So you're -- you see.
In the third quarter.
Yeah. I'm sorry, in the third quarter. Sorry, yeah, you see commercial being a big driver into the third quarter. I think you're going to see puts and takes in consumer where you see home equity and some of the other categories that we like to see drive things in card and a little bit of mortgage driving it maybe being offset by auto and student a little bit. So that's how I would articulate it. Utilization continues to increase, but it's been about 50-50 utilization and other commercial growth. And so I suspect that, that will be the color into 3Q as well, utilization driving about half of it and the other half coming from outside of utilization. But again, I'd say 3Q driven primarily by commercial loans, maybe a similar amount of the loan growth percentage that you saw in 2Q.
And one thing about commercial, and maybe I could ask Don to comment on this is that when you kind of look at how companies are able to access new financing, right now, the public markets are pretty still in the water. So you've seen kind of more opportunities for the institutional market as well. So the bank syndicated lending market has seen an uptick, which I think is likely to continue as we look out into the second half. So Don, maybe you want to give some color on that.
Yeah. I think that's right. And just to put a point on what John said, we've got utilization up by about another 200 basis points across the C&I books and the Global Markets books in the third quarter. So that gives us a couple of billion dollars in potential outstandings. To Bruce's point, we're really starting to see the acceleration of a trend of companies that might want to refinance in the bond market coming to the bank market instead because the access on bank balance sheets is so much more attractive. And we're also seeing some transitory financing for M&A transactions and for maybe some buyouts coming more onto the bank balance sheets as opposed to some of the non-bank lenders.
So I don't know what the exact mix will be, but there's a lot of things that are beginning to materialize. And it's not going to all go up because of that. We're going to take some other portfolios down and slow down some other things, similar to what Brendan said, what we've been doing for two or three years now just to change the mix of what's on the books. So, get a little more selective in terms of both returns of the capital we're deploying, but also being very careful of credit risk and the like, just in case we go into a little bit deeper slide. So, we're just being protective of the risk front also.
Yes. And one other thing, maybe just to close out there a little bit is to broaden it out to the second half. I think we mentioned -- in fact, there's a lot of moving parts here. And so we tried to really make it clear that our April guide had a 20% to 22% range of loan growth associated with it for the year and where basically -- all of these moving parts are going to fall into that range of the 20% to 22% loan growth increase in 2022. And hopefully, that's helpful. And how it shakes out between 3Q and 4Q, there's a lot going on there, but we're expecting to deliver as we indicated we would in our last guide.
Got it. Thanks for all the color.
Your next question will be from Gerard Cassidy with RBC. Go ahead.
Good morning Bruce, good morning John.
Good morning.
Hey Gerard.
Bruce, you guys have done a good job on credit, and you've identified the outlook as being healthy, strong possibly at the end of the year, but a little more cautious as we go into next year, which is completely understandable. Can you share with us what you guys are thinking about not so much the traditional credit areas like consumer lending, home equity, or student loans, but more from a institutional market if the Fed pursues this quantitative tightening, which they claim they will $95 billion a month, what kind of disruption are you guys kind of looking at possibly that could happen separate from the traditional unemployment rates going up and all that stuff, I think most of us can understand that. But the new part is this quantitative tightening that we really have inexperience. How are you guys kind of thinking about that going forward?
Well, we're a bit in uncharted waters because we haven't seen quantitative easing to the extent we have and now the amount of tightening that the planning is going to be interesting to watch. I mean if I step back and think about where did a lot of that additional liquidity end up, I think the biggest banks took on a lot of it, the custody banks took on a lot of it. And I think when we view our space, the super-regional space, maybe we had some benefit from it, but a lot of it was just working on our playbook to deliver better for customers and establish whole relationships where we can capture the deposit opportunities that we were probably sub-optimized on both on the consumer side and the commercial side.
So, I think the tightening process, you probably see it most impact the folks where the liquidity ended up, which would, in my view, be the bigger banks and the custody banks. In a bank like us, we still have a number of initiatives where I think we're not fully optimized in terms of the deposits per our relationship base, and we're going to continue to go try to gain market share and grab that.
Very good. And can you think about it also from the loan side? Do you think that the QT could have some type of impact. Obviously, it's going to take liquidity out of the market, but I don't know how you guys think about it in terms of maybe some of the syndicated business that you've been doing quite successfully in the past.
Yes. I guess I'm not -- I don't necessarily think that will be a huge driver in the loan volumes. I think the level of GDP growth and that spurs activity in the animal spirits and people wanting to put money to work. I think that's a bigger driver. But maybe on that, I'll defer over to Don. If, Don, you have any thoughts?
Yes, I'm not -- Gerard. I'm not too worried about the loan syndication piece. And again, volumes are much lower than they were, and I think they'll -- it will be where the action is, but the mega deals seem to be struggling a little bit. So if you think about the environment we're, the biggest challenge we have on transactional execution is larger transaction and then clearing through the marketplace. And so I think you'll see a little bit of a dearth there. That's not really the business we're in. So I don't think it will affect our business.
And then the other thing is you think about what's the price action that goes on in the securities market as the Fed is a seller versus a buyer. And I think one of the things that I'm looking at is the maturity ladder for corporate bonds and particularly high-yield bonds is relatively light for the next couple of years because everybody took advantage of the low interest rate environment of a couple -- over the last couple of years in refinance and push those maturities out. So I think we have some time for the market to adjust in particularly the public market to adjust to QT trend that we're going to see.
Very good. And then as a follow-up question. You guys put aside $2.1 billion, I think, of loans from Investors holding it for sale. Can you kind of give us a description of what types of loans? And you also indicated that your criticized loans on a standalone basis went down, which is good, of course. But they were stable when you included the investors criticized loans. Are any of the criticized loans for investors in the $2.1 billion held for sale?
Yes. The biggest driver of that book is an equipment finance book, which is about half of it. And there are some non-accruals that -- and non-pass assets that did go into that portfolio.
But more importantly, we think our underlying fundamentals with respect to the criticized being stable was a very good outcome. There are -- you've got some criticized coming out of ISBC with not a lot of loss content, and that's just a mechanism of migrating from the state chartered approach to how you manage that kind of stuff to an OCC-managed approach. So that was the impact there, but lost content quite low.
And on an ACL basis, pound per pound, the needs from an ACL perspective are actually lower in the ISBC side of things, given that profile that came over. So we're feeling pretty good about that.
Great. Thank you fellas. Thank you.
Sure.
Your next question will come from Erika Najarian with UBS. Go ahead.
Hi. Good morning. Just taking a step back, you guys have done a great job giving us exclusive detail in terms of what you're expecting underneath that NII outlook, I'm just wondering if we could talk about it more strategically, given how much the bank has changed since the last interest cycle. So Bruce, in the last interest rate cycle, you took advantage of putting forth great offers through Citizens Access. And I'm wondering, as you think about the composition of your balance sheet now, especially after investors, how should investors think about this go-forward Citizens deposit-gathering strategy? How aggressive are you going to be in terms of competing in rate? And is there room to lower some rates in the acquired portfolio from investors on the deposit side that would allow you to be maybe slightly more aggressive on the rate side on the Citizens Access front?
Yes. Let me start, and then I'll pass the baton here to maybe Brendan and John. But I'd say, we feel really good about the progress we've made in just reformulating the deposit base, both in consumer and in commercial. So, in consumer taking a much more relationship orientation and not having that kind of thrift like lead with rate orientation that we kind of inherited when we got here.
And so, you can just see the results of that in terms of the noninterest-bearing growth, the affluent household growth, the stickiness of the deposits and the size per household going up. So, all those trends are terrific and I think they continue. So that's a cornerstone of the deposit strategy going forward.
I think we have been pretty astute in setting up Citizens Access and giving ourselves a kind of narrow swim lane to go after interest-sensitive deposits and compete for those. I don't think that, that's ever going to really become outsized relative to the overall mix. I think it's good to have and it's -- when we need incremental deposits, we can play with the rate, we can bring them in, but it serves its purpose.
Ultimately, if we get the national bank to where we want to get it, maybe some of those deposits will be a little rate sensitive as we try to get full wallet relationships with some of the national customer base. And then on commercial, again, I think we weren't as aggressive in seeking the operating accounts as we've been over the last few years and certainly seen a lot of growth there.
And then we didn't have the full range of capabilities things like escrow services and other services that different segments of the customer base need, we weren't competitive. They weren't built out and so, we've now built those out. And so, I think our whole speed and deposit growth going forward can continue to be reasonably strong. And hopefully, we'd like to get it growing faster than kind of the peers, which would give us a lot of flexibility in terms of the amount of loan growth that we can find while maintaining an LDR in kind of the mid to upper 80s. So that's a little bit top of the house thought process around that. But Brendan, maybe you could add something on the consumer side.
Yes. I mean, on the consumer side, I'd say the last up cycle for rates was a bit of perfect storm for us for higher betas. We had a business model, as Bruce pointed out, it was more thrift-oriented, had higher promotional balances. We're growing loans materially faster than peers. So, we had to fund up the loan growth with – on a base that was a little bit less healthy than peers.
And then we did – we hadn't fully built out all of our capabilities in the bank. So, as I stare at consumer right now, I look at all of those dynamics, the underpinning health of the portfolio has remixed materially to low-cost deposits and that's based on just increased primacy and engagement with customers that’s long-term value creation, and that continues to improve quarter-over-quarter, quarter-over-quarter. That's allowed us to bring our elastic deposits down.
So last up cycle, we had something like $17 billion to $18 billion in promotionally priced elastic deposits, that's now in the mid-single digits in the core bank, putting aside Citizens Access. So the portfolio is mixed from the mid-40s percentages on low cost to -- into the 60s. That's a big buffer for better beta performance. We still believe the consumer segment will have a 25% to 30% net improvement rate cycle of rate cycle in betas.
The other things we've done is we've built a lot of tools and capabilities. So Citizens Access is now something we're very good at. But that's not it. We've built a dramatically different product composition in the core bank. We've built highly sophisticated analytic capabilities with better targeting. So we do think we can go and very targeted raise deposits in the core bank, but with a much more precision than we did in the past, which will really mute the beta impact in consumer and allow us where we need to get deposit growth. We can contain it in Citizens Access.
Last point I would make is inside the Citizens Access, we are starting to see some green shoots of deeper relationships beginning to form. So it's not just this contained deposit raising mechanism on the side. And that's going to benefit both betas but also cost. And so we're doing some tests to drive Citizens Access deposit raising across our national mortgage customers and our national student loan customers. Early results have been quite positive as we started to raise rates, and that's going to make it much more affordable for us to drive those deposits on the expense side, not just the beta side. So a lot of improvements in the health of the franchise. I would suggest the consumer bank is in a dramatically different position right now than we were five, seven years ago.
Great answer, Brendan. Don, do you want to add anything?
Yeah, I'd say similar to Brendan, I mean we basically did not have a liquidity and deposit group seven years ago when we started our journey here and our payments business was fundamentally subscale and subpar. So we're getting a good lift on the payment sales in the core operating business, as you said, Bruce, which is bringing some deposits with it. And our -- just our analytics and our capabilities, not to mention the product suite that we've begun to develop is just in a completely different place. So it's a much stronger relationship pull with the client base. As the client base grows, there's more opportunity to bring in deposits. So we feel very confident in terms of the deposit franchise at the moment.
Yeah. You're getting the whole team here, Erika, but that's a good question, obviously. But just to your other point on investors, I'd say that given our history, I think we're particularly well placed to embark upon that migration of that deposit base as well. And we'll be getting that process. We closed this quarter, and we've already begun to run our playbook through this rising rate cycle where we're lagging rate on that platform, which otherwise might not have been lagged and et cetera, et cetera. And so we're making the investments necessary. So we're optimistic that we'll begin to see some benefits coming out of that, which was also part of your question.
Great. Thank you so much.
We'll next go to Ken Usdin with Jefferies. Go ahead.
Hey, thanks guys. Good morning. Just if I can back check on a couple of things. When you refer to the April full year guidance, I think the output was plus or minus $3.4 billion-ish for the year. Is that still the zone that we're talking about as you reiterate it this quarter with a different mix?
Well, I mean, I think the -- what we're reiterating is that PPNR implied by that guide. And so yeah, I mean, I think -- and you see -- and we talked about the puts and takes on that, doing -- seeing NII coming in a little better and with some offsets and fees and expenses well controlled and well-disciplined on that and credit looking very positive and better than we expected as well.
Okay. Second question, can you give us, John, ISBC is in the full quarter? Any update on the magnitude and expected timing and run rating of the original $130 million of cost saves you expected?
Yes, I'd say the best way to think about that is by the end of the year, you'll see a run rate of about 70% of that $130 million and then the full amount of the $130 million coming in next year.
Okay. So, would you know what quarter do you expect that to be kind of fully captured?
Well, next year -- we haven't talked to it. I mean, the big driver of it is getting the closedown in the first quarter. So, it will -- substantially all of that will be done by mid-year and there'll be some trickling in benefits in the second half, but most of that will be getting there by the middle part of 2023.
Got it. And last quick one. There was an increase in short-term borrowed funds in FHLBs and I'm just wondering you had the ones that were at ISBC and you had previously talked about getting rid of those through merger accounting. So, I'm just wondering, did that chunk that came over from ISBC get taken out, or is this -- are we now seeing the adds and are there extra adds on top of it? Kind of if you could just talk through those two buckets, the short-term borrowed funds and the FHLBs relative to what might have come from ISBC or what's just new adds because of your funding mix? Thanks.
Yes. We had a carryover of about $5 billion from ISBC. And then the rest of the balance sheet flows on our end in terms of loan growth and securities growth drove the rest of the changes in the quarter.
Yes. And I would say on that, that ultimately, some of that's timing, Ken, is that the FHLB borrowings from investors will roll off, and we have cash coming in from some of the portfolios that we placed for sale. So, we would expect this is kind of a high watermark on the FHLB, all things equal and that we would bring that down by year-end.
Okay, got it. Thank you.
Your next question will come from Vivek Juneja from JPMorgan. Go ahead.
Thank you. A couple of questions. You mentioned regarding the PPNR guide well-controlled expenses. Your expenses this quarter, range you gave for last quarter, including HSBC-ISBC. When you mentioned well controlled expenses for full year 2022, can you give a little more color on what -- a little higher than where you were previously expecting? Lower? Unchanged? Any color on that?
Yes. I think we're seeing some positive benefits coming out of expenses. And so when we say well-controlled, I think we have some optimism that, that's going to be no greater than and possibly a little less than we expected.
Okay. Even though second quarter was at the high end, are you seeing some other additional costs?
That's true. If we said up 1% to 2%, given higher revenue-based compensation expense was the guide and they came in up 1%. So, I'm not sure where that's at the high end of the range.
Okay. Because I'm just looking at reported Bruce, and I see you were at 16% to 18%, it came in at 18% on reported.
Yes. I mean you have to look at underlying because that's really the integration costs that ticked that up. So, if you look at our underlying, we actually thought we did a really good job to keep them virtually flat. And then we would expect that strong performance to continue into Q3. And we called out, I think, maybe 4% for the whole year. It's roughly where we are, so.
And just on the integration cost, in fact, we did see more integration costs this quarter, but that's not signaling higher integration costs. It's just the opposite. We're pulling some into this quarter. We're expecting integration costs overall to be lower than we announced at…
That was just a pull forward the back in Q2.
Okay. That's helpful. That's a completely different question. Early delinquencies, can you give us the numbers by loan category for second quarter 2022, meaning 30 to 89-day delinquencies?
Overall, in the consumer side, delinquencies have been flat to even some signals of being very modestly down. Actually, we're seeing in no portfolio that we're looking at, do we see any signs of reinflation both at the 30-day level all the way through 90 days. So with a 120-day cycle to get to a net charge-off, it would take a whole heck of a lot of what you would need to believe to see net charge-offs in the consumer segment go up materially between now and the end of the year.
Obviously, the place we're watching on the net charge-off line is things like used car values and recoveries on the resi portfolio, but those have been very stable and very high and very positive. We don't expect that to move very much either. So just the message overall in the consumer segment side is everything remains in great shape and without really any signs of a tick up, and the fundamentals remain strong too. Consumers still have 25%, 30% more in liquidity and deposits than pre-COVID and customer pay rates on credit cards pay in full, still are in the low 40 percentile. That was in the low 30s before COVID.
So to believe that you'd start to see delinquency ticking up, you'd first probably see deposits start to burn down and you start to see customers relevering. We're not seeing that. Now we're a little bit unique from some peers in that our customer base skews much more mass affluent and affluent. But even when the same segment…
Credit score was super prime and high prime.
We're super prime lender, where you see some market commentary on early signs of credit. It tends to be in the subprime space, and we don't have any of those businesses, but we don't see any signs of credit stress in any portfolio really across any of the segments that we're in.
Okay. And not even in the other retail partnerships you've put on the point of sale, are you seeing any stretching by consumers there in terms of levering up more?
No, I would direct you to a month or two ago, John and I went to the Morgan Stanley conference, and we shared some credit stress portfolio-by-portfolio. The Citizens Pay portfolio is performing exceptionally well and is, in fact, multiples below our prime credit card portfolio. And so not only is it super prime, but it's performing four, five, six times better than even a credit card portfolio. So we feel very good about that…
And that's because we draw a tight credit box in terms of what we are willing to take on the…
Exactly. And where you start to -- we've been very ambitious on our desire to grow that business. But we've been disciplined on credit, and we're not going to -- we're not going to be undisciplined on credit in that business to drive growth. And so where we've been slower to see growth manifest in Citizens Pay, it's because we're not willing to jeopardize our credit discipline, and I don't see equally any signs of stress whatsoever on the Citizens Pay portfolio remains in great shape.
Great. Thank you.
Sure. Okay.
There are no further questions in queue. And with that, I'll turn it back over to Mr. Van Saun for closing remarks.
All right. Well, thanks again for dialing in today. We appreciate everyone's interest and support. Have a great day. Thank you.
Ladies and gentlemen, that will conclude your conference call for today. Thank you for your participation. You may now disconnect.