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 2023 Earnings Conference Call. My name is Alan, and I will 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 will 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.
And with that, I will hand over to you Bruce.
Thanks, Kristin, and good morning, everyone. Thanks for joining our call today.
The turbulent external environment continued in the second quarter, but we continue to navigate well and we delivered solid financial performance. In particular, we're pleased with the strong results we achieved around capital, liquidity and funding. Our CET1 ratio grew by 30 basis points to 10.3% in the quarter and we were able to repurchase in excess of $250 million in stock. We grew spot deposits by 3% or $5.5 billion and our spot loan-to-deposit ratio improved to 85%. Our federal home loan bank borrowings dropped by $7 billion to $5 billion and contingent liquidity grew by 20% to $79 billion.
For the quarter, we posted underlying earnings per share of $1.04 an ROTCE of 13.9%. NII was down 3% reflecting higher funding costs, in line with our expectations. Non-interest income grew 4%, slightly less than expected as capital markets saw a few deals pushed to the third quarter. The expenses were broadly stable as expected and credit cost continue to be manageable.
One of the highlights of the second quarter was the opportunity to secure a significant influx of talent, largely from the First Republic platform to meaningfully augment our Citizens Private Bank and Wealth Management business. While expense investments will lead revenues in 2023, we project the business to be accretive in 2024 and significantly profitable in the medium term.
In our presentation this morning, we will highlight this initiative in more detail. And we'll also review several other compelling initiatives that we believe will lead to strong medium-term outperformance. Execution of these initiatives continues to be strong.
We're setting up a non-core run-off portfolio as a centerpiece of intensified balance sheet optimization efforts. We expect around $9 billion of loan run-off, largely in auto by the end of 2025. This capacity will be utilized to fund more strategic loan portfolios, to pay down high-cost debt, and to build cash and securities.
In parallel, the Private Bank will grow loans over this period by $9 billion, which will be funded by $11 billion of incremental deposits. The net benefit of all of this is a better deployment of capital, along with the positive impact on earnings per share, ROTCE and liquidity.
We've also included more detail on our CRE loan portfolio. Our general office reserve is now at 8%. While we continue to see increases in criticized assets and charge-offs in this particular portfolio, we believe losses are manageable and readily absorbed by reserves and our strong capital position.
Looking forward, we anticipate that the environment while stabilizing, will continue to be challenging. Our net interest margin will decline again in Q3, given higher funding costs. We expect our terminal beta to reach 49% to 50% at year end. Our fees to continue to grow sequentially. Expenses will be well-controlled and credit should be broadly stable. We will further build our CET1 ratio while continuing to repurchase shares.
Overall, we're holding in okay on current-period performance with mid-teens ROTCE in 2023, while making the investments to deliver a stronger franchise, attractive growth and returns, and afforded by balance sheet over the medium-term. We continue to build a great bank and we remain very excited about our future. Our capital strength and our attractive franchise, position us to attract terrific talent and to take advantage of opportunities as they arise.
With that, let me turn it over to John to take you through more of the financial details. John?
Thanks, Bruce, and good morning everyone.
Let me start with the headlines for the second quarter, referencing Slide 5. For the second quarter, we generated underlying net income of $531 million and EPS of $1.04. Our underlying ROTCE for the quarter was 13.9%. Net interest income was down 3% linked-quarter, and our margin was 3.17%, down 13 basis points with funding costs outpacing the increase in asset yields.
We delivered very strong deposit growth in the quarter, reflecting the strength of the franchise with spot deposits up 3% or $5.5 billion. Period-end loans and average loans were down 2% quarter-over quarter, reflecting the impact of our balance sheet optimization efforts, including our ongoing run-off of auto. These dynamics improved our period end LDR to 85% and our liquidity position remains very strong.
We reduced FHLB borrowings by about $7 billion to approximately $5 billion outstanding at quarter-end and we increased our available liquidity by 19% to about $79 billion. Our credit metrics and overall position remains solid. Total NCOs of 40 basis points are up 6 basis points linked-quarter as expected, primarily reflecting higher charge-offs, increased general office.
We recorded a provision for credit losses of $176 million and a reserve build of $24 million this quarter, increasing our ACL coverage to 1.52% up from 1.47% at the end of the first quarter, with the increase directed to the general office portfolio. We repurchased $256 million of common shares in the second quarter and delivered a strong CET1 ratio of 10.3%, up from 10% in the first quarter. And our tangible book value per share is down 2% linked-quarter, reflecting AOCI impacts associated with higher rates.
On the next few slides, I'll provide further details related to second quarter results. On Slide 6, net interest income was down 3%, primarily reflecting a lower net interest margin, which was down 13 basis points to 3.17% with the increase in asset yields, more than offset by higher funding costs, given the competitive environment and migration from lower cost categories.
With Fed funds increasing 500 basis points since the end of 2021, our cumulative interest-bearing deposit beta is 42% through the second quarter which has been rising in response to the rate and competitive environment and is generally in the pack with peers. Our asset sensitivity at the end of the second quarter is still approximately 1% which is broadly stable with the prior quarter. Our received fixed cash flow swap position is similar to the prior quarter as we held off on adding further protection as rates continued to rise during the quarter.
Moving on to Slide 7, we posted a solid fee performance in a challenging market environment. Fees were up 4% linked-quarter with card fees showing a seasonally strong increase from higher transaction volumes and increases in wealth and mortgage banking fees.
FX and derivatives revenue was modestly lower. Capital markets fees were stable with market volatility through the quarter continuing to impact underwriting fees, largely offset by increased syndications and M&A advisory fees, despite a few deals being pushed into the third quarter. We continue to see good strength in our deal pipelines and are hopeful that deal flow picks up in the second half.
Mortgage fees were slightly higher as production fees increased with market volumes, partially offset by lower margins and lower servicing fees. And finally, wealth fees were also up slightly reflecting growth in AUM.
On Slide 8, expenses were broadly stable linked-quarter as seasonally lower salaries and employee benefits were offset by higher equipment and software costs, as well as higher advertising and deposit insurance costs.
On Slide 9, average and period-end loans were both down 2% linked-quarter, reflecting balance sheet optimization actions in C&I, as well as the impact of planned auto runoff. Education was lower given the rate environment, but this was offset by modest growth in mortgage and from equity. Commercial utilization was down a bit as clients look to deleverage, given higher rates and we saw less M&A financing activity in the face of an uncertain economic environment.
On Slide 10, period-end deposits were up $5.5 billion or 3% linked-quarter with growth led by consumer up $3 billion and commercial up $2 billion. Our interest-bearing deposit costs were up 47 basis points, which translates to a 101% sequential beta and a 42% cumulative beta.
Strong deposit flows and a very successful auto loan collateralized borrowing program initiated during the quarter contributed to reducing FHLB levels by about $7 billion. Given our BSO objectives, we grew deposits, which drove a favorable mix-shift away from wholesale funding. As a result, our total cost of funds was relatively well-behaved up 38 basis points.
Next, I'll move to Slide 11 to highlight the strength of our deposit franchise. With 67% of our deposits skewed toward consumer and highly-diversified across product mix and channels, we are able to efficiently and cost effectively manage our deposits in a rising rate environment. We increased the portion of our insured and secured deposits from 68% to 70% linked-quarter and when combined with our available liquidity of $79 billion, our available liquidity as a percentage of uninsured deposits increased to about 150% from around 120% in the first quarter.
As rates grew another 25 basis points in the second quarter, we saw continued migration of lower-cost deposits to higher-yielding categories, primarily in commercial with noninterest bearing now representing about 23% of the book. This is back to pre-pandemic levels and should stabilize from here.
Moving on to Slide 12. We saw a good credit results in retail again this quarter and higher charge-offs in commercial. Net charge-offs were 40 basis points, up 6 basis points linked-quarter, which reflects an increase in the general office segment of commercial real-estate, partly offset by a slight improvement in retail, primarily due to the strength in used-car values.
Nonperforming loans are 79 basis points of total loans, up 15 basis points from the first quarter, reflecting an increase in general office, which tends to be lumpy. It's also worth noting that overall delinquencies were lower sequentially with retail and commercial both improving slightly. Retail delinquencies continue to remain favorable to historical levels.
Turning to Slide 13, I'll walk through the drivers of the allowance this quarter. We increased our allowance by $24 million, which includes a $41 million increase in CRE general office, even after covering charge-offs of $56 million. Our overall coverage ratio stands at 1.52%, which is a 5 basis points increase in the second quarter. The runoff of the noncore portfolio primarily auto, facilitated the reallocation of reserves to CRE. The reserve coverage in general office was increased to a strong 8%.
On Slide 14, you'll 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 $313 million this quarter which represents coverage of 8%.
In addition to running a number of stress scenarios across the general office portfolio, we continuously perform a detailed loan level analysis that takes into account property-specific details, such as location, building quality, operating performance and maturity.
We have a very experienced CRE team more focused on managing the portfolio on a loan-by-loan basis and engaging in ongoing discussions with sponsors to work-through the property and borrower-specific elements to derisk the portfolio and ultimately minimize losses. Our reserves reflect this detailed view of the portfolio as well as the key macro factors we set out on the page.
The property value, default rate and loss severity assumptions we are using to set the reserve, are adequate for the risks we currently see and are significantly more conservative than what we've seen in previous CRE downturns. It's worth noting that the financial impact of any further deterioration behind what we expect would be very manageable, given our strong reserve and capital position.
On the following Slide 15, there are some additional disclosures we are providing this quarter to give more detail on the type and location of the general office portfolio. You can see out of the $3.9 billion general office portfolio, 94% is Class A or B with the majority in suburban areas, which seem to be performing better than central business districts.
On the bottom left-hand side of the page, it highlights that the portfolio is quite diversified across geographies, as well as the top 10 MSAs, listed on the bottom right-hand side. Broadly for New York MSA, we are starting to see return to office trends picking-up and more than 80% of the portfolio was outside Manhattan where property dynamics tend to be more favorable. Washington DC is 100% class A&D and 95% suburban.
Moving to Slide 16, we maintained excellent balance sheet strength. Our CET1 ratio increased to 10.3% as we look to add capital given the uncertain macro and regulatory environment. We returned a total of $461 million to shareholders through share repurchases and dividends.
Turning to Slide 17. You'll see that our CET1 ratio is among the highest in our regional bank peer group. This strong capital level reflects a relatively conservative approach since the IPO in maintaining robust capital levels. If you incorporate the removal of AOCI opt-out, our adjusted CET1 ratio would be 0.5% and we also expect that this replace us near the top of our peer group again this quarter. We expect to maintain very strong capital levels going forward with the ability to generate roughly 20 basis points of CET1 ratio post-dividend each quarter in 2H '23 before share buybacks.
So, as you see, we've been focused for a while and playing really strong defense with a focus on capital, liquidity, funding and maintaining a prudent credit risk appetite. And that's the job one. Even long before the turmoil we saw in the first quarter. But we also recognized the need to continue to play offense. We need to be selective, investing in initiatives that will grow the franchise where we have a right to win.
Over the next few slides, I'll spotlight a few of the exciting things we're doing and ensure that we can deliver growth and strong returns for our shareholders. First, on Slides 19 and 20, we were excited to announce a few weeks back that we hired about 50 senior private bankers and 100 related support professionals who were with First Republic. As many of you know, for a number of years, we've had an interest in growing our wealth business, both organically and inorganically.
So we made a number of investments on the organic side, hiring financial advisors and converting that business from a transactional business to a very customer-centric financial planning approach. That's been a slow and steady build over the years. And then we supplemented that with the Clarfeld acquisition a couple of years ago and that's gone incredibly well.
So, with our customer-centric culture, our financial strength and the full range of products and services we offer, we were the perfect fit for these bankers. We really admire their approach to delivering the bank to their customers in a unique way with white glove service. This is really 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. In fact, we think the overlap with JMP in San Francisco is extremely complementary.
These bankers serve the types of customers we are seeking to attract to the bank, high and ultra-high-net-worth individuals and families, often the strong connections to middle-market companies with a particular focus on private equity and venture capital firms, serving the innovation economy. We have a great deal of work ahead of us to integrate these teams and ensure that they are positioned to deliver that bank to their clients. We plan to open a few private banking centers in key geographies and build appropriate scale in our wealth business with Clarfeld as the centerpiece of that effort.
We think this is going to be extremely attractive from a financial perspective. These teams and their staff, about 150 people in total, on-boarded late in the second quarter with revenue begin to ramp in the fourth quarter. Financial impact for the second half will be $0.08 to $0.10 of EPS plus an initial notable cost of about $0.03 for 2023.
These bankers have hit the ground running and are out-working to build their book of business and we expect the effort to breakeven around the middle of 2024. By 2025, we expect EPS accretion of roughly 5% with 2025 year end projections of about $9 billion in loans, $11 billion of deposits and $10 billion of assets under management. So overall, a very exciting advance for us.
Now let's go to Slide 21, and I'll walk you through how we'll be managing our balance sheet over the next few years. Since the IPO, we're prudently growing our balance sheet while managing the mix of assets and funding with an eye towards maximizing returns. With the increase in rates since the end of 2021, plus the advent of quantitative tightening and more recently, the heightened competition for deposits, we are entering the next stage of the journey with a plan to focus on attractive relationship lending, while lowering our LDR, which will improve our liquidity profile and benefit returns.
In order to make this effort clear and show the benefits we expect, we've established a $14 billion non-core portfolio which is comprised of our $10 billion shorter duration indirect auto portfolio and lower relationship purchased customer loans - consumer loans. This portfolio will run down fairly quickly with about $9 billion of run-off expected by the end of 2025.
Moving to Slides 22 and 23, you'll see that as the non-core loan portfolio runs down, this allows us to pay down higher-cost funding and redeploy capital into more strategic lending and our investment portfolio. We will also be growing relationship-based lending to the private bank and raising deposits to self-fund that growth.
Despite the size of the run-off portfolio, we expect to see modest loan growth in 2024, picking up in 2025, driven by opportunities across retail and C&I as well as our private bank effort. The net result of these actions is an improved liquidity profile with a better loan and funding mix and higher returns.
Next on Slide 24, a quick update on our entry into New York Metro where some really exciting things are happening. With the branch conversions behind us, we are full steam ahead working to serve our customers and capitalize on opportunities. We continue to be encouraged by our early success. We've seen strong sales in the branches as we leverage our full customer service capabilities to drive some of the highest customer acquisition and sales rates in their network. Most importantly, we have seen a steady improvement in our Net Promoter Scores.
On the commercial banking side, we've got a strong new leadership team in place with local talent joining from larger firms and we are seeing some early success leveraging our new visibility to build pipelines with middle-market firms. And we are looking forward to what we can do with our new private banking capabilities in the market.
On Slide 25, we have a great opportunity to build on Citizens Access, our national digital platform that has been focused on deposits for the last few years. We moved to a modern fully cloud-based core platform and we are trying to add checking capabilities later this year. Down the road, we plan to converge our legacy core system with this modern platform. We are confident that a single integrated platform will be more cost-efficient and flexible in meeting our client's needs. We aim for this to be a complete digital bank experience to serve customers nationwide with a focus on the young mass-affluent market segment.
And on the right side of the page is CitizensPay where we have been very innovative in creating distinctive ways to serve customers. CitizensPay has been the top customer acquisition engine for the bank with very high promoter scores and this has been a great performer from a credit perspective. We have some fantastic partners on the platform for a while, such as Apple, Microsoft, Best Buy, BJ's and Vivint. And we are always very excited to welcome new partners like Peloton, Tre, The Tile Shop and Wisetack to platform.
On Slide 26, I'll highlight how we are positioned to support the significant growth in private capital. Over the last several years, private capital fundraising had led - has led to record deal formation, M&A activity and substantial fees. The activity has been relatively muted recently and many sponsors have not deployed meaningful amounts of capital. So there is a tremendous amount of pent-up demand for M&A and capital markets activity. We have been executing a consistent strategy to serve the sponsor community with distinctive capabilities for the last 10 years and we've done a great job moving up to the top of the sponsor lead tables, particularly in the middle market.
We have made significant investments in talent and capabilities, including five advisory acquisitions since 2017. And our new private bankers significantly expand our sponsor relationships and capabilities. Our success supporting private capital has been a large part of our strong capital markets performance over the last few years and we are poised to capitalize on the next wave of sponsor activity as the path of the economy becomes clearer.
Let's move to Slide 27 for an update on our TOP program. Our latest TOP 8 program is well underway and progressing well. Given the external environment, we have decided to augment the program to protect returns as well as ensure that we can continue to make the important investments in our business to drive future performance. We have increased our targeted benefit by $15 million to $115 million by accelerating some of our other efforts and to further rationalize our branch network and reduce procurement costs.
We have also begun planning for our TOP 9 program, looking for efficiency opportunities driven by further automation and the use of AI to better serve our customers. We are also looking at ways to simplify our organization and find even more savings in procurement. Continuous improvement is part of our DNA and I'm very confident that we'll continue to deliver these benefits to the bank.
Moving to Slide 28, I'll walk through the outlook for the second quarter for Citizens, which excludes the impact of the Private Bank and I will also provide some comments for the full year. The outlook takes into account another rate increase, followed by Fed on hold for the remainder of this year. For the third quarter, we expect NII to decrease about 4%. Noninterest income to be up by approximately 3%. Net interest expense should be broadly stable. Net charge-offs are expected to be broadly stable to up slightly. Our CET1 is expected to rise modestly from 10.3% with additional share repurchases planned, which will depend upon our ongoing assessment of the external environment.
Relating to the full year, our liquidity position is quite strong and given the BSO actions I discussed earlier, we will continue to build on this, targeting an LDR of low-to mid-80s by the end of the year, positioning us well for anticipated regulatory changes. Worth noting we are already - we already are fully LDR compliant with Category 3 bank requirements.
Based on the forward curve, we are expecting a terminal interest-bearing deposit beta of 49% to 50%. Our net interest margin should begin to stabilize in Q4 as the Fed is expected to reach the end of the rate hike cycle. We are off to a great start of drilling up the private bank, and we expect the EPS impact of this to be $0.06 in the third quarter and $0.02 to $0.04 in the fourth quarter. So we really think of this as a capital investment.
To wrap up, our results were solid for the quarter as we continue to navigate a turbulent external environment. We are focused on positioning the company with a strong capital, liquidity and funding position, which will serve us well as we continue to navigate a challenging environment ahead. Our balance sheet strength also positions us very well to focus on our strategic priorities to continue to strengthen the franchise for the future and deliver attractive returns.
With that, I'll hand back over to Bruce.
Okay. Thanks, John. Alan, let's open it up for some Q&A.
Thank you. Thank you, Mr. Van Saun, we are now ready for the Q&A portion of the conference call. [Operator Instructions] Your first question will come from Scott Siefers with Piper Sandler. Go ahead.
Good morning, everybody. Thank you for taking the question. I guess first question is just on the sort of accretion to the margin from the balance sheet optimization. Do you have a sense for what sort of steady-state margin from Citizens might look like after that is completed. I guess, it doesn't necessarily have to be a specific number, but just in your view how powerful is that accretion from these activities? And I appreciate that sort of the backdrop of the 4.2% yield versus the 5.5% funding costs.
Yes, I'll go ahead and start off. Thanks for the question. I mean, I think, broadly, we're seeing the impact of the rate environment on our net interest margin. We're managing it quite well as the Fed is continuing on its hiking cycle. And as you get into the end of the year, taking into consideration all of the balance sheet optimization activities, we see NIM flattening out and kind of holding it around 3% or so, as you get to the end of the year.
The tailwinds from balance sheet optimization are meaningful and will continue to build into '24 and so those are the big drivers there, I think that also contributing to that NIM stability would be the fact that we think that balance sheet migration is starting to stabilize. And also you can ignore the fact that the Private Bank itself as you get out into '24, would start to deliver accretive NIM. So we're feeling good about the profile after we get through this last hikes from the Fed here in July, watching that NIM starts to stabilize as you get into the end of the year.
Okay, perfect. Thank you. And then is it possible to put sort of a finer point on the, I guess 8% to 10% - pardon me, $0.08 to $0.10 of cumulative expected EPS drag from the Private Bank initiatives. Certainly appreciate the sort of the loan and deposit in asset management or assets under management outlooks, but maybe any broad sense dollar value of expected revenues and expenses as we look into the second half.
Yes. And it's a little bit front-end loaded as the expenses will come in and drive probably more in the neighborhood of $0.06 of that $0.08 to $0.10 happening in third quarter with $0.02 to $0.04 really into the fourth quarter. And it's primarily expenses in the neighborhood of $40 million or so, as you get into the 3Q and 4Q and but the loan book starts to build later this quarter and into 4Q. So that gives you the front-end loaded of that $0.08 to $0.10 into 3Q.
The one thing I would say to that, Scott, it's Bruce, is, this is a very sound approach to scaling up the wealth business. We've been looking for acquisition ideas and it's been very expensive with very long tangible book value earn backs, many times would be over five years, which is beyond our appetite. So to actually do this in a kind of de novo build-up basis, you incur some capital expense in the short run, but it's almost the same as if you kind of equate it to an outlays that ultimately starts to generate revenues.
And the nice thing about this is that it's accretive already in the second year and kind of earn-back on this thing is under two years. So we look at it really less as a driver of how does it affect the near-term EPS. But look, there is a capital outlay, which we burn some expense dollars to get it off the ground and then all of a sudden, it's making us money and it really ramps very nicely and can achieve something like a 5% accretion in 2025, which is kind of within 2.5 years, in the second year of doing a deal If you compare that to some of the other transactions that we've done, including the bank acquisitions, it's pretty darn powerful. So very excited about this opportunity.
Perfect. Okay, good. Thank you very much.
Your next question will come from the line of Erika Najarian with UBS. Go ahead.
Hi, good morning. John, I was just wondering if you can help us with lots of moving pieces that's sort of unfurling in front of us. So, just I guess, the first question is, you noted stability in the 3% - at the 3% level. Does that mean that fourth quarter 2024 will be at about the third quarter level? I'm just wondering sort of how those dynamics play out in terms of what you expect to the - how the balance sheet trend for the rest of the year or those sort of the run-off continue to pressure it at that level and what does that fourth quarter NII about look like from a range perspective.
Yes. I mean, I think from the NIM standpoint, you're talking about '23, just confirming, Erika, is that -
'23. And building out of '24 fund.
Yes, no, you referenced '24. But the answer is actually a little bit similar, but what we do see is, after the Fed hikes here in July and that the impact of that burns in in the third quarter that we do see NIM flattening out there between 3Q and 4Q, having a more flat profile as you get into the end of the year around 3%.
So maybe a touch higher in 3Q net interest margin, but seeing that profile begin to flatten out and I think the key drivers of that, the pieces in parts as I mentioned, we're starting to see the deceleration in deposit migration, the negative deposit migration. So that's a good early green shoot, that's consistent with the fact that our DDA levels are basically where we were back to pre-pandemic. And so that ends up being at an expected landing zone as you get into the end-of-the year.
So we'll see that flattening out. You'll see the tailwinds from this - from the runoff block starting to kick in, the reallocation of that capital and liquidity into relationship lending and the ability to pay-down some higher-cost funding as you get into the end of the year. And so that starts to bolster net interest margin, which we do think carries into '24, and we think that there are a number of positive developments in '24 that would allow us to hold that NIM out into even beyond the fourth quarter.
And I would comment, Erika, that this was a really important quarter for us to kind of get the deposit level where we wanted to get the Fed - the Federal Home Loan Bank borrowings lower and really take a big step in lowering the LVR. And so we paid up a little bit to achieve that and the impact of that full quarter effects the third quarter guide, but I think at this point, we feel that we don't need to continue to really aggressively grow deposits. We can have a more stable deposit profile.
As John indicated, less migration from non-interest bearing to interest-bearing and so there won't be kind of a full quarter impact of an aggressive plan that affects Q4 from Q3, because we'll be kind of looking at a more stable profile in Q3.
Got it. And so, thank you for that, Bruce. So, as I think about the fourth quarter, is it fair then to say that your guidance implies NII of $1.52 billion for the third quarter, so do we assume that we're at or around that range for the fourth quarter and as we think about the puts and takes of 2024 and John, I have to bring this up because few investors were noting - I think now at Slide 31, where you have some swaps rolling-off that have very heavy weighted-average fixed rate that you're receiving. So as I think about $1.52 billion perhaps is a starting point plus or minus, I assume that the - your guide were down 100 basis points. NII for the full year down 1.2%, it's still valid if we assume rate cuts next year and includes those swap roll-off. So that's sort of the first question.
And the second is, how does balance sheet optimization impact that sensitivity? So I'm assuming that's extraordinarily static. So - and I'm assuming that's from - both sides are paying off more debt next year as you were waiting for these loans to come on and then - as you wait for these loans, you're also putting it in higher-yielding in cash. So, if you could just help us think through the moving pieces as it relates to that original disclosure because I think investors are thinking about the potential for rate cuts next year.
Yes. Maybe I'll just start off in a couple of areas. Just when you think about NII, similar numbers that you're throwing out there are probably a little lighter than where we will see them come out. I think our NII be a little better than that and into fourth quarter, I think we have some opportunities to - if interest earning assets are going to be stabilized, as Bruce indicated and net interest margin stabilized, so we think the NII has also stabilized at that solid levels. So that was I think the first question that you had. I mean I think the -
Just to put a point on that too is, any swap impacts are in our forward guide, Erika. So we've already contemplated that. So there's nothing and they didn't really move. We didn't do any adjustments in the second quarter, so.
Yes, there is a very limited adjustments. Things do roll-off and come on, but broadly, our asset sensitivity profile was pretty stable quarter-over-quarter, meaning we are - we were still asset sensitive. So a rate rise, which we're about to get from the Fed does actually contribute to NII and net interest margin for us.
So from that perspective, all of that has been built into the commentary that we've been giving you in terms of swap roll-off and our ongoing positive asset sensitivity. Again, when you get - when you think about net interest margin over kind of the next several quarters, we have a number of tailwinds. You've got flattening out non-interest-bearing migration. So that's no longer expected to be a big headwind. You've got the run-off book that we talked about and that runoff book is going to be rotated into relationship lending at higher yields. So the runoff -
Paying off high-cost debt.
And paying down high cost funding, right, so which - where we have a negative kind of spread situation there. We already mentioned the fact that the Private Bank is going to start contributing to the balance sheet later this year and that the net interest margin on that is actually accretive to the overall legacy bank. I think, throughout there is that, just front book back book dynamics, where you basically have originations in the front book.
Just in the securities portfolio alone, there's 300 basis points positive front book, back book in terms of - we're actually creating a bigger security stock, but we're doing at the right time where securities yields are actually historically quite favorable. And so we're putting a lot of way from that standpoint. And we're seeing back into the loan book, spreads on our front book originations are higher than they were. And for example in C&I, spreads are up 50 basis points over the last year, year-over-year. So that's also a tailwind and all those things are the things that are going to help us manage the fact that - manage the rate environment and the other items that we have --
So I think what John described, Erika, is a number of tailwinds that should be positive. So if the Fed is cutting next year, that potentially is a negative, but we have these positive things to offset that, which gives us kind of that stable view on the NIM into '24.
Got it. And just to wrap it up, just because I got a few emails to clarify and I'll step aside. It sounds like you're sensitivity hasn't changed or whatever that fourth quarter number is, which is stable to the third quarter, that down 1.2% on down 100 is still valid, but then the balance sheet optimization will get you closer to stable despite Fed cuts.
Yes, agree. So balance sheet optimization plus the fact that when if rates were - rates begin to fall, if they do, we don't have that happening in the fourth quarter by the way. We have that happening in '24. We have the Fed on-hold for the rest of the year and we have the Fed just based on the forward curve, right, having the Fed ending around 4% in '24. So it's really until '24, where you see those down rate scenarios.
And in the down rate scenario, I mean, that's where deposit betas start working for you rather than against you. And so, then you start getting some of that coming in as well as the fixed loan portfolio that creates a buffer when rates start to fall and so I would just add those two things to all the other tailwinds I already articulated as to why we feel like we could hold the stable NIM.
Yes, I'll just close and you got an extended period of time here, Erika, and we're very interested in NII and NIM, which I'm sure is on a lot of investors' minds. But, kind of bigger picture is, we're kind of transitioning the loan book to things that are more strategic and offer better returns on capital and better opportunities for cross-selling deepening with customers.
And so we're kind of working through a transition period this year and even into next year. It's a little hard to give you full guidance at this point, given a lot of uncertainty still in the market. We're giving you our best instincts at this point on that. But I feel quite confident that as we kind of emerge through '24 and then even look out to '25, that - kind of, with the lift-off of this Private Bank effort and the kind of run-down of these less strategic portfolios that we're going to get a lot of benefit from this and we're really poised to do quite well, I think looking out into kind of back-half of '24 into '25.
Yes, Bruce that Private Bank lift-out is a bold move. I think everybody just wanted to figure out what that run rate look like and I think this conversation we just had, clarified that run rate. So, thank you.
Sure.
Your next question will come from the line of Matt O'Connor with Deutsche Bank. Go ahead.
Hi, good morning. This is Nate Stein on behalf of Matt O'Connor. Just one question from me. So the capital build was good this quarter with the CET1 rising to 10.3% from 10% and guidance calls for this increase again in 3Q. Just wanted to ask how high are you willing to let the ratio get to?
I think - it's Bruce. I think, by the end of the year, we could see it getting to 10.5% which is a bit above our stated range have been 9.5% to 10%. I think given all the uncertainty that's out there in the economy plus direction of travel from regulators, that managing it up like that is sensible. Having said that, we're still generating quite good returns, which gives us the ability to kind of nudge that up from here in terms of the ratio, but also repurchase our stock, which we think is great value at the current pricing. So that's how we're looking at it.
And then, as we go through 2024 at this point, our early thoughts would be kind of more of the same that we can at least hold that 10.5% and maybe build on it based on what we see from regulators. But we have the wherewithal to be in the market buying our stock on a consistent basis and holding or building that ratio further.
Thank you.
Your next question will come from the line of Gerard Cassidy with RBC. Go ahead.
Good morning, Bruce. Good morning, John.
Hi, Gerard.
Bruce and John, can you guys share with us, obviously, Vice Chair Barr came out with a speech last week talking about RWA increases that will lead to higher capital levels for all banks over $100 billion in assets. Have you guys given some thought on where this could be - where you could be most impacted by the new Basel 3 Endgame that maybe will come out next week. And then second, as part of this, this week Bloomberg reported that there may even be some RWA increases for residential mortgages which really hasn't been discussed. And how are you guys approaching, what could be coming possibly as soon as next week?
Let me start up. Quickly flip it to John. But, clearly, I would say there's mixed views on whether that's - sound proposal at this point and I think the industry itself - liquidity itself very well through the pandemic, through this period of turmoil in the first half of the year and I think many folks have commented that the industry has strong capital and so in response to three idiosyncratic bank failures, is it appropriate that the thing that needs to be fixed is more capital in the banking system.
I don't know. I question whether that's appropriate, and we'll see how it plays out. I think there'll be lots of dialogue around that. I think from our standpoint, by moving our capital position higher, we're anticipating any of what could come down the pike is something that we can absorb. We're in a very strong position relative to our SCB, which, by the way, we still have some questions about how it landed where it did but nonetheless we're well above that. And we're well above if the AOCI filter goes away, we already have sufficient capital to meet our new propose SCB. So we're in a position of strength, Gerard.
I think we can still deliver the kind of returns we aspire to over time as we get through this transition period and hit our medium-term financial targets. But I would kind of at least comment that I'm not sure that that's the answer when we had a series of management supervisory failures and poor asset liability management. That really was the problem that caused this term off, not a lack of capital in the banking system. So I'll get off my soapbox and I'll pass it over to John.
Yes, I agree with all of that. And I think the issue is in credit RWA versus operational risk RWA, Gerard. So, I think there was the view that there would be some puts and takes on the credit risk RWA and maybe it wouldn't be much of an increase expected at the regional bank level, but I did see - we did see those reports on residential mortgages. We'll see how it all plays out. But on the operational risk side of things, with a complex fee-based sort of businesses are where a lot of that is directed and it's not just - we don't have much of exposure - as much of exposure to that as maybe some other banks in the industry do.
So broadly we felt like that we would be impacted possibly a little less than most and we're sitting with capital a little more than most. So from that perspective, we feel pretty well-positioned for the uncertainty of the regulatory. We are making process and as you heard from Bruce, we're growing capital into the end of the year and I think a 10 - something in the neighborhood of 10.5% CET1 is a pretty strong mitigant to anything that might come down the road from the Fed.
Great, thank you, guys.
Your next question will come from the line of Ken Usdin with Jefferies. Go ahead.
Hi, thanks, good morning. I just wanted to follow-up on the strategic remixing and wondering, can you give us some color on the types of loans and deposits that you think will come over as part of that - those new hires in the Private Bank. I mean, obviously, the First Republic mix have been kind of low-rate mortgages and high-rate CDs. I would expect that not the type of NIM you're looking to be adding. So just wondering just - what those producers you are expecting to bring over and also kind of we could see it in your AUM expectation, but it looks like it will be more NII delivering as opposed to fees.
Turn that over to Brendan.
Yes, so, we are really excited obviously about this initiative and it's a very strategic acceleration of our Wealth Management business. But to your point, it does come with scaling up the bank as well while we are aiming to recreate a lot of the customer experience magic that existed in these private banking models. We're going to make some structural changes to make sure that the profile of the business that we get is accretive at the top of the house.
So what you can expect from us is disciplined credit pricing that while will be competitive, we're not going to kind of lead with undercutting the market and pricing to make sure we have the right margin. We will have an incredibly disciplined credit appetite. We don't expect to take a step forward or step in the wrong direction in terms of credit risk profile. In fact, we think this will enhance the credit risk profile with very low-risk loan generation.
We are going to ensure that we're driving lendable deposits on the balance sheet that we put out relative to the Private Bank that we're getting core operating deposits, whether that's from individuals or from businesses. It's really important that we maintain a sound liquidity position in this growth.
And lastly, from a compensation perspective, we're going to rationalize the compensation model the best we can within the confines of a private bank to ensure that those - the combination of those factors give us a return profile that can be accretive at the top of the house on overall ROE, but also on things like NIM.
So the balance sheet on the deposit side, certainly we have the mix of cash management operating deposits as well as interest-bearing. But we are going to heather all relationships to being primary banking, whether it's corporate or whether it's personal. So you could expect low cost DDA to be mixed in with interest-bearing for a healthy profile primary banking relationships.
On the asset side, I'd say we're expecting about a 50/50 mix, what I would call sort of consumer personal retail lending and small-business and corporate lending. And on the personal lending side, really the large asset classes are going to be mortgage, home equity, and eventually partner loan program, where we are putting capital to individuals to engage as a partner and a higher-end consulting firm or private-equity firm, very traditional low-risk assets. But this lodges the operating deposits and ultimately lead you to AUM.
And on the business side, as mentioned earlier, the profile of the team we got over, does have a bent towards the innovation economy. So we're expecting capital call line lending to dislodge operating deposit relationships with private equity and venture. And small segment where it's appropriate relationship-wise on potentially multifamily in a very-high credit environment where we can also secure the personal wealth relationship.
All of our balance sheet usage will be oriented around full end-to-end customer relationships that include deposits and ultimately AUM growth. So it's a very integrated end-to-end business model and we feel like we've got the right recreation of the service strategy, married with the right corrections to the business model to ensure we get better profitability and also a stable business model that can withstand the test of time. If that - we think we can get a really good growth around this, but we will control the growth with a guardrail of adequate profile of the business that will be healthy and profitable over the long haul.
Great color. Thank you, Brendan. And just one more question on the other side of the BSO. John, obviously talking a lot about the consumer side of the non-core portfolio here. Can you just dig and just let us know, you previously had done a lot on the commercial portfolio. And I'm just wondering, have you done any key currently deep diving into the CRE book, as you've talked about on the credit side. What might there still be to do on the commercial side of the portfolio in terms of BSO from that perspective. Thanks.
Yes. I mean, I think, and as you know in this portfolio that we set up, that's - it's entirely a retail portfolio in terms of that $14 billion, but there are nevertheless in parallel BSO activity is continuing in the commercial side, and let Don talk about that.
Yes, so we've been at this for probably three or four years now as we just grown out relationships where we haven't been able to achieve across all that we've thought we have been achieved when we were going into the credit, several years ago. So it's really an ongoing effort. It's been running about $1 billion a year, and we probably will be running about that same pace. The good news is we've been able to replace some of that with growth in places like New York Metro, where we see a good amount of opportunity on a full wallet basis, particularly in the middle market, as we bring on these new hires.
On the CRE side, as everybody knows, there is not a lot of liquidity, but there is some liquidity and we're actually moving some of our exposures after the agencies and then do some private capital also. So we'll try to liquefy CRE, particularly multifamily over the next couple of quarters, couple of years to the best we can bring those overall exposures down, even though they're performing pretty well.
Good. Okay, thank you very much.
Your next question will come from the line of John Pancari with Evercore. Go ahead.
Good morning. Just on the capital side, I heard you in terms of the CET1 trajectory from here, and that it does still allow for some repurchases. Maybe could you help us frame out what's a reasonable pace of buybacks we should assume which is similar to $250 million that you did this quarter?
Yes. I would say that is something we felt comfortable with in Q3. We were going through the Q2. We were going through the CCAR process at the time, but we saw the opportunity to build kind of have our cake and needed to build the ratio while also repurchasing shares and I think we'll still be in that position. So we still have noncore kind of rundown working for us, which is releasing RWAs. So you should again have a chance to somewhat - have your cake and needed to both in Q3 and Q4.
Okay, thank you, Bruce. And then on the non-interest bearing mix stabilizing at the 23% near the 2Q level. Now what gives you confidence in the stabilization? I know you mentioned that you're not pushing as aggressively. You don't see the need to now on competition on pricing, is there anything that will beyond that in terms of depositor behavior that you're beginning to see that gives you that confidence that this is where it's bottoming?
Yes, I think there's two items that we look at. One is just the - as we are getting back to the historical place that the platform generated noninterest-bearing pre-pandemic, and so that's been sort of a foundational spot that we think creates some solidify of the operating accounts in both retail and consumer. So that's one really important spot. So around that 23% level is about how we see it.
And then the second item is that, in the second quarter, we started to see some deceleration for the first time in several quarters. We started to see the turn and deposits kind of migration decelerating. And then we have a number of, I would say activities on the product and low-cost strategy front that we're seeing some really positive uptick on in retail, in particular, and so -
Let's ask Brendan to pick up and add some color.
Yes, couple of quick points, just a quick recall, as we've talked over the last bunch of quarters. The consumer portfolio has been under a five-six year transformation for quite some time and it's in a very, very different starting points through the beginning of the cycle than ever before for this franchise with significant improvements in things like customer primary - primacy growth and households, or mass-affluent mix has improved and low-cost deposit profile has moved up.
So coming into the cycle, we were very confident that we'd be more pure like or maybe outperform and data that we're seeing with benchmarking suggested in the consumer bank, we are indeed better-than-average versus peers right now on all the mentions interest-bearing cost, beta, as well as low-cost control.
So we feel pretty good how we're performing against peers, it is starting to stabilize. So the excess surge deposits have burned down maybe by about 60%, so there's still a little bit out there. But a lot of those are starting to be sticky and turn into wealth creation. If you dissect the various different segments, the wealthier segment is still having some modest outflows of rotation into interest-bearing as well as rotation outside of the banking industry. So year-over-year the wealthier segment is down about 10%.
We're seeing the mass-affluent segment in deposits on a per customer basis about flat and the mass-market portfolio has actually increased in net deposits and that's a function of a lot of our strategies that we put in place to really drive primacy and activity and engagement. And so we've seen a bit of a bottoming at the lower end in terms of DDA balances.
What we have done to drive that is a lot of product innovation. So we did things like get your paycheck two days early. It doesn't seem like a big deal, it's actually an incredibly big deal. That's driving a lot of primary banking behavior. We've got technology we put in place that when you open a new DDA, you're automatically porting over your direct deposit that seems very operationally oriented. But it actually is a dramatic improvement that things like primary banking behavior which drives low-cost deposits.
We've made overdraft perform through our Peace of Mind 24-Hour Grace program and a variety of other things, which has also driven a lot of primacy and we're starting to really rev up the engines on household growth. Overall, all of those things contribute to some controllable. So we're - I think we're outperforming peers on the market, given our starting point in the cycle and we're continuing to invest to try to further outperform through all of these different initiatives and strategies. It is the long game. These are driving primacy in low-cost deposits. It takes a while to build up scale, but I feel like we've got a lot of the right things in place in addition to outperforming on our back-book to win the game uncontrollable where we're at right now.
So, well, your two-thirds of the deposit base and have all these great strategies you have done. You've also been investing in payments capabilities and some new products like sustainable deposits. Maybe you could just offer a brief comment.
Yes, that's right. I mean, we've been broadening out our deposit base quite nicely and as Bruce said, it's a combination of just the growth in the cash management business overall and bringing on more clients on the cash management side. As I said, in New York Metro, the things that we're adding are really full wallet for cash management relationships and those bring really nice deposits.
And then on the product side, we've done a lot around green deposits and carbon offsets deposits in our ESG strategy that was approved to be quite profitable. We've built out escrow products and bankruptcy products. So there's a variety of product development things which are attracting nice operating deposits with some nice breadth for them.
Right. Thank you.
Okay, great. Thanks.
Your next question will come from the line of Manan Gosalia with Morgan Stanley. Go ahead.
Hi, good morning, I appreciate all the detail on the office book. It looks like you have a pretty conservative assumption baked into your CRE office reserve levels of 8%. What - I guess the question is, what would you need to see to take that up even more. Or over the next few quarters, as some of your office portfolio comes up for renewal, should we expect the reserve levels go down as you have more normalized NCOs in that portfolio?
Let me start. And John or Don can add. But we feel quite good about A), the overall nature of what we have, and B) then - so there's good diversification, good quality characteristics. We have some really good people that are really focused hard on this and they are monitoring this loan-by-loan. They see the upcoming maturities to get way in front of those. So we're having good dialog with borrowers. And I'd say, we did a good job - relatively good job in the first half of absorbing some of maturities. Probably about 30 loans, I think came up for maturity, which is about the number that we're going to have in the second half and it's about the number that we're going to have in the first half of next year. It's about the number that we're going to have in the fourth quarter and next year.
And if you look at the net result of that, while we have an increase in criticized, we have an increase this quarter was a little lumpy in NPAs in this sector and that probably levels off. I'd say, we were able to build our reserve and absorb charge-offs. So we took $56 million in charge-offs. So that's another kind of 1.5% loss content. If you look at the 8%, it's effectively higher while what we just absorbed.
And so, could we go for another few quarters with absorbing charge-offs on a pay-as-you-go basis with what we're providing and hold the reserve flat? Yes, possibly, that could happen. And then at some point, does that tip over and then you don't need as much reserves because you burned some of those losses through your charge-off line. So anybody, that's just a little color about how we think about it, John. I don't know if you want to add anything to go direct to Don.
Yes. I'll just reiterate the fact that, as you mentioned, we took $56 million, that's a 1.5%. So that - we've got 8.5% - we got 8% set-aside, so that implies a 9.5% coverage for the losses through the cycle and we think that's pretty darn adequate, matter of fact, very strong. And so, I think that - as you also mentioned NPLs flattening out and charge-offs kind of getting in the run-rate rather than step-change from here which I think is important to reemphasize.
And maybe just turn it over to Don.
I think you guys have said it was 26 loans, so you're pretty close to the 30. That's pretty good that you know that. But I think the thing I'd emphasize is we've literally gone through every single loan one by one. Everyone is different. It's property-specific, it's MSA-specific, it's rental-specific, its sponsor-specific. And we're just seeing - we're starting to see outcomes. And outcomes are a property gets extended and renegotiated with the sponsor. You might have a little bit of equity injected to improve interest carry, and you might charge it off. So - and I think that we have a pretty good eye to the path of the book as we look forward.
And things could always change, but I think we feel pretty comfortable that we've been very conservative based on what we see. And I will emphasize, I mean, we're not originating anything really of any scale and origination. So our whole origination team, in addition to our credit team, in addition to our work path team, is focused on working with our sponsors to basically -
In the office sector.
In the office sector, yes. And the rest - by the way, the rest of the real estate, both multifamily and industrial data centers, I think, it looks like it's holding up extremely well. We're really not seeing any weakness that concerns us at all in the rest of those slip up.
That's very helpful. Thanks for the fulsome answer. Just to move on to capital. Is there any color you can share on what drove the increase in the stress capital buffer this year? I know that mortgage was something that was a little bit of a headwind for the whole group, but any other information you glean from your conversations with the Fed. And then maybe what you need to do to bring that down in future years?
Yes. I - we haven't really had the full debrief. So we are getting that set up so we can go through and kind of understand their models better. I think that's been one of the concerns of the industry that it's not that transparent to us. But kind of when we look at the results, there's a couple of things that could have been a factor.
So one is the build of the allowance when we took relatively high charge-offs we had a significant build was built into their models, which we didn't have in our models. And that alone probably cost us 30 basis points of a 60% increase or something like that. So that's one thing that we'll want to talk about and understand better.
And then questions about we did a deal and did the onetime expenses get incorporated or we've done a lot of hedging in the falling rate scenario are our hedges getting full benefit. So we just have some questions that we want to poke at.
But in any case, I think the bigger point here is that we can roll with this 8.5% and we have plenty of capital, and we have an appreciable buffer versus that capital. So it really doesn't affect kind of our capital management strategies. But we would like to see it get kind of back into line. We think it's a bit elevated relative to where it should be, and we'll be having those conversations with the Fed in the coming weeks.
Yes. I think that as you get past this year, where we have those integration expenses, and there's a hypothesis that, but that will roll off as you get into next year. And we'll have another bite at the apple next year given the fact that we're going to be doing this again. And in the end, the SCB is not our constraint. Our constraint is our own view of what capital we need to be prudent to support our business. And frankly, where the Fed and the regulators are headed with required kind of levels outside of the SCB is going to be our constraint. So we're going to be, as Bruce mentioned earlier, about 200 basis points over the SCB by the end of the year and probably heading towards earlier compliance with whatever the Fed comes out within most. So we're feeling pretty darn good about the capital position, notwithstanding the SCB.
Got it. And the BSO should have a positive impact on your risk-weighted assets. Should that also have a positive impact on the SCB?
No, it will - it might. I mean, I think more importantly, it will - it gives us flexibility to rotate RWA capital into relationship lending and return that capital. To the extent that those front book opportunities are not there, we probably have the opportunity to do both, where we rotate that capital into relationship lending and provide an ability to buy back. It doesn't have a direct impact on the SCB.
Great. Thank you.
Your next question will come from the line of Vivek Juneja. Go ahead.
Hi, thank you. Just a follow-up on the First Republic banker question. Bruce, Brendon, would requirements do you - what are your pricing assumptions? You said you're trying to bring the pricing to yours, but then what are the assumptions for what the bankers need to deliver to be able to recoup their - or earn their guarantees? And secondly, given that this was a white glove service, which is obviously very expensive, what changes are you planning to make to that to be able to get to your hurdle profitability targets?
Yes. Yes, thanks for the question. We already, prior to the lift-out of the private bankers, had a relationship-based pricing in play in all of our asset classes, including mortgage. So when you bring heavy levels of deposits in AUM, we price down modestly for that. So we don't have any intention of changing what we already do.
And so our new private bankers will have access to the same relationship pricing grids that we've had in play for a while. So as you think about pricing and yields of things like mortgages or even some of the small business commercial lending, we're not expecting a dramatic different profile in terms of profitability or yields from legacy Citizens in how we operate the business to make sure that we're considering the full relationship and that we're really competitive in pricing. But we're not undercutting the market by a material amount that will deteriorate either lending return -
And I think the corollary to that is that the teams that came over understand that.
They do.
So I'd say the one thing that they won't have in their arsenal is deeply discounted mortgages. But I think they come in with their eyes wide open on that. And quite honestly, the deeply discounted mortgages are probably now back on your balance sheet because people aren't refinancing those at a good clip. So they'll probably sit there for a long time. But anyway, we will kind of do business in a commercial way. And again, the bigger the relationship, the better the pricing generally. And so I think the team coming over is very comfortable with that.
And another question around expenses, implied in the comments that John and Bruce both made around breakevens inside of 2024 is the team's production covering kind of TOP guarantees to come over. So we've been really thoughtful about how we do that. But obviously, we've got the way these folks get paid is on a book of business model. And they're going to go out and develop a lot of business, and we're going to give them the runway to do that. We had a lot of debate with them on the appropriate timing to make that happen and make sure the operations excellence is available here at Citizens. The cost of that is considered in all of our guidance and commentary we made about the profitability of the business. And we're already well underway on tinkering with the way the bank works to make sure we're creating the conditions for them.
Yes. And I'd say there, we probably had the brakes on a little bit to make sure that we get it to the level because you kind of get one shot with some of these customers. And so we've got a full effort on making sure that we get to the standards that we need. I would say one other silver lining from that also is that, that will help us up our game in customer experience more broadly, the kind of initiatives that we're taking to make sure that we make this a great experience. There'll be some things that spin off from that, that we can move to other parts of the bank, without a question.
Okay. Thank you. And for a follow-up, just Don. Don, what are you seeing on the whole sponsor side given with high rates in the market? When - what level do you expect it to come back to even in '24, say, just given if rates stay high, yes, some cuts, but I don't think anybody is expecting it to go back to where we were 1.5 years ago? So any thoughts on what level of activity do you think we get back?
We'll see. High level, our pipelines are about 30% higher than they were at this time last quarter. So we're seeing the pipelines build. Sponsors are certainly engaging in conversations whether they can get to actual transactions or not, although there have been. Some there was a Worldpay transaction that was announced a few weeks ago. So we're beginning to see some transactions. Remember, one of the things that we benefit from, and I've said this a couple of quarters, is we tend to play in smaller deals, right? So we're $100 million to $750 million to $1 billion in terms of deal size, whether it be advisory or financing. We were number one in the middle-market leveraged finance league tables in the last quarter. Volumes were down, but we were the number one institution playing.
So we're gaining share for what's available. So do I think we're going to be back to 2021 levels? No. But I think if you get stability in rates, it's the beginning of deal formation will happen, and it will just depend on valuation dynamics between sponsors and sellers. And there's just a lot of companies in our portfolio that just need to sell.
They want to sell for generational leases. So there are things that are available, deals make it over-equitized just to keep the interest burden down if value doesn't come down. But we're starting to see a lot of conversations going. So I don't think we're going to be off to the races, but I think it's going to continually build. And I think '24 could be a pretty good year.
Thank you.
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. Thanks, Alan, and thanks again, everyone, for dialing in today. We certainly appreciate your interest and support. Have a great day.
Ladies and gentlemen, that will conclude your conference call for today. Thank you for your participation. You may now disconnect.