Citizens Financial Group Inc

NYSE:CFG

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, everyone, and welcome to the Citizens Financial Group Third Quarter 2022 Earnings Conference Call. My name is Alan, and I'll be your operator today. [Operator Instructions] 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.

[Kristin Silberberg, Executive Vice President, Investor Relations]

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 third 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 third quarter earnings presentation located on our Investor Relations website.

After the presentation, we will be happy to take questions. Our comments today will include forward-looking statements, which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are outlined for your review on Page 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.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Thanks, Kristin. Good morning, everyone. Thanks for joining our call today.

We delivered another very strong quarterly result in Q3. Rising rates positively impacted our net interest income and net interest margin. Fees and expenses were broadly stable and credit performance remains excellent. We grew average loans 2% and deposits 1% as our liquidity and funding position remains strong and our CET1 ratio of 9.8% is above the midpoint of our 9.5% to 10% target range.

Our TCE to total asset ratio sits at 6.1%. Performance metrics include a net interest margin of 3.25% and that's up 21 basis points. We had positive sequential operating leverage of 6%. We had hit an efficiency ratio below 55% and our return on tangible common equity was around 18%. We built our credit reserves by $49 million with our ACL at 1.41%, and that's above the 1. 3% day 1 CECL reserve adjusted for the Investors acquisition. Beyond these impressive financial results, we've continued to make good progress in executing our strategic initiatives.

In Consumer, we launched Citizens Private Client, which will help drive wealth opportunities. We migrated our national digital bank to a modern cloud-based platform. We continue to grow share with Citizens Pay, and we're executing well on our expansion into New York City Metro region.

In Commercial, we've successfully integrated recent acquisitions like JMP and DH Capital into our coverage and product model. Our M&A pipelines are at record levels and our geographic and industry vertical build-out is delivering strong results in terms of market share gains. Enterprise wide, we're successfully ramping up our TOP 7 program, while building out TOP 8. Stay tuned on that. Our NextGen Tech program has really been the standout initiative that has been a game changer for us. These programs demonstrate our mindset of continuous improvement finding ways to run the bank more efficiently so we can deliver positive operating leverage and self-fund investments for our future. We're also doing some interesting things in DSG such as developing a carbon offset program for clients as well as investing in a virtual power agreement that delivers clean energy, and we have more interesting innovation in the pipeline.

As we look forward to Q4 in 2023, we feel that we are well positioned to deliver strong results and to keep growing and enhancing our franchise value. We are well prepared for challenges that may materialize in the macro environment with a really strong balance sheet position and highly prudent credit risk appetite. But we also plan to keep playing disciplined offense with continuing investments in our growth initiatives.

The current environment gives us a great opportunity to prove our metal and deliver responsible, sustainable growth. One aspect that we emphasize in today's presentation is our confidence in the quality of our deposit base, but we've been able to transform over time. We've had good deposit stability over the past couple of quarters, as some peers are seeing outflows, and our deposit betas are back in line with the pack.

We're seeing very strong loan betas and expect these to remain above deposit betas through 2024, assuming the current forward curve. As a result, our NIM will continue to rise more gradually as time goes on. We've also layered in sizable net interest rate hedges to protect NIM and ROTCE through 2024 if the Fed reverses and brings down short-term rates, moving off of the zero bound for short rates has unlocked the value of our deposit franchise and significantly benefited our ROTCE.

With a clearer macro outlook and less market volatility, we feel the value of our commercial bank build-out will also manifest, benefiting further our ROTCE. So very exciting time for Citizens.

And with that, I'll stop and turn it over to John to cover the financials in more detail. John?

[John Woods, Chief Financial Officer]

Thanks, Bruce, and good morning, everyone. First, I'll start with our headlines for the quarter, referencing Slide 5. We reported underlying net income of $669 million and EPS of $1.30. Our underlying ROTCE for the quarter was 17.9%. Net interest income was up 11% linked quarter, driven by a 21 basis point improvement in margin to 3.25% and 2% growth in average interest-earning assets. Average loans are up 2% linked quarter, with 3% growth in commercial. Fees were fairly stable, down 2% linked quarter as our client hedging business returned to more historical levels following an exceptional first half of the year and mortgage results softened a bit.

Capital markets fees and service charges were stable. We remain highly disciplined on expenses, which are up 1% linked quarter. Overall, we delivered underlying positive operating leverage of 6% linked quarter, and our underlying efficiency ratio improved to 54.9%. We recorded a provision for credit losses of $123 million and a reserve build of $49 million this quarter, which reflects an increased risk of recession, partly offset by improvement in portfolio mix.

Our ACL ratio stands at 1.41%, up from 1.37% at the end of the second quarter and compares with a pro forma day 1 CECL reserve of approximately 1.3%. Our tangible book value per share is down 8.6% linked quarter, driven by the impact of higher long-term rates on AOCI. We continue to have a very strong capital position with our CET1 ratio at 9.8%, just above the midpoint of our target range.

Next, I'll provide further details related to third quarter results. On Slide 6, net interest income was up 11%, given higher net interest margin and 2% growth in interest-earning assets. The net interest margin was 3.25%, up 21 basis points. As you can see on the new block in the bottom left-hand side of the slide, the healthy increase in asset yields outpaced funding costs, reflecting the asset sensitivity of our balance sheet.

Moving to Slide 7. With the current expectation for the Fed to rates further, 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 year-to-date and those benefits will continue to accumulate into the fourth quarter and compound into 2023. Our overall asset sensitivity increased to approximately 3.3% at the end of the third quarter, up from 2.6% for the second quarter, primarily driven by the impact of variable rate loan originations.

Our asset sensitivity will allow us to have further upside as the forward curve continues to evolve. We expect cumulative loan betas to exceed the positive betas through the rate cycle. Our interest-bearing deposit beta is tracking well within our expectations, and the ultimate outcome will depend upon the pace and level of Fed rate hikes from here.

So far in this cycle, with Fed funds increasing 225 basis points since 4Q '21, our cumulative interest-bearing deposit beta is well controlled at 18% through the end of the third quarter. On a sequential basis, our deposit beta was 26%. We began the rate cycle with a strong liquidity and funding profile, including significant improvements through our deposit mix and capabilities. We will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits.

We continue to execute our hedging strategy to managing a more predictable and stable outlook for NII as we benefit from the higher rate environment. You'll find a summary of our hedge position in the appendix on Slide 23. In the third quarter, we did an additional $10 billion of hedges with a focus on extending our protection out through 2024 and beyond, primarily through forward starting swaps.

We expect our NIM to rise to 3.5% or better by the end of 2023 and for our overall hedge position to provide a NIM floor of about 3.25% through the fourth quarter of 2024 if we see rates come down by 200 basis points across the forward curve before it could move higher with further hedge actions.

Moving on to Slide 8. We posted good fee results despite headwinds from continued market volatility and higher rates. These were fairly stable, down 2% linked quarter as our client hedging business returned to more historical levels following an exceptional first half of the year. Car fees were strong again this quarter, while capital markets and service charges were stable. Focusing on capital markets, market volatility continued to impact the bond and equity markets. M&A advisory fees picked up nicely, but this was offset by lower loan syndication revenue amid increased economic uncertainty and market volatility.

We continue to see good strength in our M&A pipeline to continue to build with strong pinch activity and a growing backlog. While current market volatility may constrain the ability for deals to close, capital markets fees should see some seasonal improvement in the fourth quarter, particularly in M&A advisory even more broadly if markets settle down. Mortgage fees were softer as the higher rate environment weighed on production volumes, which more than offset the fact that production margins improved modestly this quarter, but still remain below historical levels.

We are seeing signs of the industry reducing capacity, which should benefit margins over time and servicing operating fees were stable. Wealth fees are $5 million lower linked quarter given the impact of lower market levels on AUM. And in other income, we saw a seasonal benefit from our tax advantaged investments and an increase in leasing revenue.

On Slide 9, expenses were well controlled, up 1% linked quarter. Our TOP 7 efficiency program is continuing to make good progress and is on track to deliver over $115 million of pretax run rate benefits by the end of the year. Average loans on Slide 10 were up 2% linked quarter driven by 3% growth in commercial with growth in C&I and CRE, given modestly higher loan utilization and slower paydowns.

Retail loans increased 1% with growth in mortgage and home equity, offsetting planned runoff in auto. Period-end loans were broadly stable linked quarter given higher-than-usual end-of-quarter C&I line paydown, which were generally redrawn after quarter end.

On Slide 11, average deposits were up $1.3 billion or 1% linked quarter, with growth coming from retail term deposits and Citizens Access savings and commercial banking deposits were broadly stable.

Deposit costs remain well controlled. Our interest-bearing deposit costs were up 38 basis points, which translates to an 18% cumulative beta. We feel good about how we are optimizing deposit costs in this rate environment, and our performance to date is reflective of the investments need to strengthen our deposit franchise since the IPO. Overall, liquidity improved as we reduced our FHLB advances by $2.3 billion and increased our cash position at quarter end.

Moving on to Slide 12. We saw good credit results again this quarter across the retail and commercial portfolios. Net charge-offs were 19 basis points, up 6 basis points linked quarter, but still very low relative to historical levels. Nonperforming loans were broadly stable at 55 basis points of total loans. Given the higher risk of recession, we are watching our loan portfolio very carefully for early signs of stress, in particular, pre office, leveraged loans and selected nonprofit sectors.

At this point, we aren't seeing significant issues emerge. Also, the leading indicators for consumer continue to be stable and favorable to pre-pandemic levels. Personal disposable income has declined from stimulus-driven highs but remains above the pre-pandemic 2019 average.

Spending for travel and restaurants remain steady and above pre-pandemic levels, while credit card and home equity line utilization are still well below pre-pandemic levels. And 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 continue to see very good credit performance across the retail and commercial portfolios. While we aren't seeing stress in the portfolio at this point, we increased our allowance by $49 million to take into account an increased risk of recession, partly offset by improvement in portfolio mix. Our overall coverage ratio stands at 1.41% which is a modest increase from the second quarter.

If you recall, when we adopted CECL at the beginning of 2020, our coverage ratio was 1.47%. However, given the Investors acquisition and some shifts in the portfolio mix, we estimate our pro forma day 1 CECL allowance to be approximately 1.3%. The current reserve level contemplates a shallow recession and incorporates the risk of added stress on certain portfolios including those subject to higher risk term inflation, supply chain issues and return to office trends.

Moving to Slide 14. We maintained excellent balance sheet strength. Our CET1 ratio increased to 9.8%, which is slightly above the midpoint of our target range. This, combined with our strong earnings outlook puts us in a position to resume share repurchases in the fourth quarter. Tangible book value per share and the tangible common equity ratios were both reduced by the impact of higher long-term rates on AOCI. We have increased our held to maturity portfolio for about 30% of total loans at quarter end which has helped to mitigate the impact of rising rates.

Our fundamental priorities for deploying capital have not changed, and you can expect us to remain extremely disciplined in how we manage capital allocation. Shifting gears a bit. On Slides 15 and 16, you'll see some examples of the progress we made against the key strategic initiatives and what's on tap for our businesses in the near term.

Since we closed the Investors acquisition in April, we've been executing against a phased approach to the integration. In the second quarter, we began originating mortgages on our systems. And since then, we have completed the conversion of mortgage servicing. We also successfully completed the conversion of more than 10,000 Investors' wealth clients, representing about $1.6 billion in assets to our platform. We have a lot more to do, but I'm pleased to say that we are on track to complete the deposit and branch conversions in mid-first quarter 2023. We have included a high-level integration timeline in the appendix on Slide 22.

Importantly, we remain on target to achieve our planned $130 million of run rate net expense synergies by the end of 2023 of which approximately 70% will be achieved by the end of 2022. We also continue to expect that the integration costs will come in below our initial estimates. In the last three years, we have launched a collection of new banking products and features that make it easier to bank with us. Last week, we announced the next step in that evolution with CitizensPlus, which provides financial rewards, banking features and tailored advice that grows with customers from everyday banking to personalized wealth management.

This includes Citizens Private Client our new expanded wealth management offering, which will launch by the end of the year. We are fully committed to driving momentum in our wealth business. And as part of the launch, we are hiring more than 200 new financial advisors and relationship managers. We continue to make meaningful strides forward with our national digital strategy and tech modernization. Earlier this year, we migrated Citizens Access to a fully cloud native platform, and we launched a national storefront adding mortgage and education refis to the portal. Over the next year or so, we plan to expand our national storefront, adding card and checking first and then Wealth and Citizens Pay. As we add products to the platform, we have an exciting opportunity to build relationships across a growing national customer base.

Our vision is to migrate our core branch deposits to this modern platform over time, which will be a key change in efficiency and flexibility in terms of implementing upgrades and enhancements. We are also growing our innovative Citizens Pay offering, which is currently at about 160 merchant partners and expanding across targeted verticals.

Over the next year, we are working to launch a new mobile app and a unique customer direct experience.

Moving to the commercial business on Slide 16. Over the past eight years, we've invested heavily in talent and product capabilities in M&A, corporate finance, bond and equity underwriting, FX and commodities and so on.

Despite the challenging environment, we remain near the top of the league tables, consistently ranking in the top 10 as a middle market and sponsor book runner and helping corporates and private equity sponsors access capital through the public markets. We have also integrated our cash management and global market solutions as well with our coverage. We are excited about the potential synergies from our recent acquisitions as we target growth in key verticals the JMP acquisition gets us much deeper into the growing healthcare, technology and financial services sectors, expands our equity underwriting and adds research capabilities and DH Capital expands our capabilities in the Internet infrastructure, communication sectors, software and next-generation IT services. These businesses are exceptionally well positioned for when markets reopen.

Moving to Slide 17, I'll walk through the outlook for the fourth quarter. We expect NII to be up roughly 3%, driven by the benefit of higher rates with a margin rising to the 3.3% to 3.35% range. Average loans are expected to be stable to up modestly as commercial growth is partially offset by order rundown. These are expected to be stable to up modestly. Noninterest expense is expected to be stable. Net charge-offs are expected to be approximately 20 basis points to 22 basis points. We expect our CET1 ratio to land near the upper end of our target range of 9.5% to 10%. And our tax rate should come in at approximately 22%.

With respect to the full year, we continue to track well and expect to beat our full year 2022 guidance across key P&L categories and performance measures. We expect to deliver positive operating leverage for full year 2022 in excess of 5%, with fourth quarter sequential positive operating leverage of about 3%. We also expect to deliver a full year efficiency ratio of about 57% with the fourth quarter coming in under 54%. And we expect to deliver a full year ROTCE in excess of 16% with the fourth quarter well above both Q3 and our medium-term target range of 14% to 16%.

To sum up, on Slide 18, we delivered a strong quarter amid a dynamic environment, and we are optimistic about the outlook for the fourth quarter and into 2023. We expect to continue to see significant benefits in our net interest income from the higher rate environment. Our diverse fee business is driving solid results and our capital markets business, in particular, is well positioned for when markets stabilize. And our commitment to operating efficiency remains a hallmark. We are well prepared for a slowdown in the environment with a strong capital, liquidity and funding position, and we are being prudent with respect to our credit risk appetite and loan growth.

At the same time, we are playing some offense, executing well on strategic initiatives in each of our businesses that will deliver medium-term growth and outperformance.

With that, I'll hand it back over to Bruce.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Okay. Thank you, John. Alan, why don't we open it up for some Q&A?

[Operator]

Thank you, Mr. Van Saun. [Operator Instructions] Your first question comes from Scott Siefers with Piper Sandler.

[Scott Siefers, Piper Sandler]

If you could expand a little on your thoughts regarding NII dynamics into next year? I thought the 3.50 year-end '23 margin expectation. That was definitely a highlight. And I think just generally, your comments about loan betas overwhelming deposit betas sort of cumulatively those suggest some confidence that and I should continue to grow after the Fed stops tightening, but I just would love to hear your thoughts on the puts and takes and the additional color you might be willing to add.

[John Woods, Chief Financial Officer]

Yes, sure. So just break it down into two overall categories. You've got the net interest margin dynamic, which is a big driver, and we're messaging that. We expect our net interest margin to continue to rise. I think loan betas in the last cycle for us were up near 60% or so this cycle, we're doing some more hedging. So you could see our loan betas dropping a little bit. The nice part about that is that it provides a downside protection.

So you're going to see loan betas in the mid- to -- sort of low to mid-50s. You compare that to a deposit beta, that we previously messaged, would be around 35% or so. Rates have been up 100 basis points since then. I mean you could see our deposit betas may be getting into the upper 30s or thereabouts given -- cumulatively what's going on with rates in the last -- in the recent couple of months.

So you take that dynamic and see cumulative loan betas and exceeding deposit betas and that drives names higher. We're also remixing on the loan side into more variable. You're seeing the strength of the multiyear investments on the deposit side playing. And then let's not forget the other aspects of the balance sheet where you've got securities book and that securities book is funded primarily by DDA and some wholesale. And so you can see the front book, back book dynamics really taking hold where you've got securities yields on the front book in the fourth quarter somewhere between 4.50% and 5% with a 2% runoff.

And so that's pretty powerful when you've got essentially a strong DDA underpinning what's going on there in the securities book. So those are some of the net interest margin dynamics. If you flip forward to the other side of things where you see our opportunity for continued loan growth, we're -- you're seeing us rotate into more of a variable rate approach, solid opportunities in home equity and other aspects in the retail side. But commercial is -- we're feeling optimistic on the commercial side and that's going to drive loan growth into '23.

It will be economic environment dependent. But nevertheless, the underpinning of rising NIMs, I think, is really what gives us the confidence to continue to see that NII improving into '23.

[Scott Siefers, Piper Sandler]

All right. That's perfect color. And I guess just with rates having moved so much, just curious about your thoughts on sort of the Citizens Access products. What kind of trends are you observing about sort of the stickiness of those customers? How much is loyal? How much are sort of shopping for rates? And are your tactics at all changing with regards to that product?

[Bruce Van Saun, Chairman & Chief Executive Officer]

Brendan, why don't you take that one?

[Brendan Coughlin, Head, Consumer Banking]

Yes. Thanks. We're seeing some decent growth in Citizens Access. And the digital native customer still existing out there, and it's waking up a little bit as rates have gone up. So we're -- it's been a very, very effective strategy for us. The customers are loyal to Citizens. We're seeing good augmentation from those customers, a very real brand engaged customers. And the customer base is growing.

So our balance growth is coming from both sides, new customer acquisition and existing customers bringing us more as we brought rates up. But most importantly, it serves to sort of have an isolated deposit-raising strategy to protect the core bank from needing to bring in rate-sensitive customers into the bank. We're really relationship focused in our core franchise and the combination of the health of our deposit franchise improvement led by DDA and privacy of our customers has been really showing up well.

So our deposit betas in consumer are dramatically different than they were in the last cycle. And it's really for both of those points, the turnaround and the health of the customer franchise and the core bank and then the effective strategy of using access both to drive national growth but also to have a much more targeted and isolated way to grow interest-bearing deposits. It doesn't make us reprice our whole book. So we're really pleased with how it's playing out. And Citizens Access is right where we thought it would be, and it's being executed really well.

[John Woods, Chief Financial Officer]

Then the strategic aspects of Citizens Access that over time is just another benefit of that platform.

[Brendan Coughlin, Head, Consumer Banking]

Correct. I think that's what, obviously, we've messaged on these calls before. But the integration of our Citizens Access deposit platform with all of our national lending businesses to make our national platform much more integrated and customer strategic. John mentioned the launch of our new app and our cloud-based migration. We are making really sizable progress on bringing together all of our national capabilities to deepen those relationships as well as just sort of the deposit angle that we launched with a couple of years back.

[Operator]

Your next question comes from the line of Erika Najarian with UBS.

[Erika Najarian, UBS]

My first question is for you, Bruce. You have teased that your TOP 8 is underway. And as we think about how much you've improved the bank, and John has certainly helped balance sheet and Brendon and Don have helped balance sheet positioning, what is your vision for what Top could accomplish? So we're looking at a bank clearly outperforming the market today, outperforming expectations.

It feels like a lot of the big rates of change have been accomplished in the previous 7 plans. So and that's sort of the genesis of the question. What do you envision TOP 8 to accomplish?

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes. Well, Erika, I think when we ended up hitting the TOP 2 and TOP 3, we were getting questions as to how much re-architecture and reengineering of how you're running the bank is left. Is the -- are you now picking the fruit that's really high in the tree. And yes, it was getting higher in the tree. But I think what we've been able to do is exhibit this mindset of continuous improvement that we're not going to be satisfied with how we're running the bank and we're going to look at all aspects in terms of how we're staffed and organized and our vendor relationships and other kind of efficiency new technology deployment to deliver more efficiencies.

And so over time, that's just become part of our DNA here. And so we're not going to rest and say, well, we just had another successful result with TOP 7. Let's take a breather, you really can't take a breather because we have investments that we want to fund in our future, the business initiatives that we list on a couple of the slides in Consumer and Commercial, and that requires net investment in CapEx and OpEx and in order to fund those things, having these top programs and finding efficiencies to self-finance those investments and keep the overall rate of expense growth modest is the equation that we've used to drive ROTCE from the 5% when we started at the IPO to 18% levels today.

So I think you're going to continue to see us pursue that mindset of continuous improvement and don't be surprised when we have a successful announcement and execution of TOP 8 that there might be even more TOP programs down the road after that.

[Erika Najarian, UBS]

Got it. And just a few clean-up questions. Thank you so much for giving us a lot of color on the ACL. I'm wondering what the weighted average unemployment rate that you assume in the 1.41 ACL today. And just, John, a quick clean-up question to Scott's line of questioning. As we think about the NII dynamics into next year, what are you assuming about deposit growth and deposit mix shift?

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes. I'll just take the -- the first one is, we're using some fairly conservative assumptions when we set the ACL. So I would characterize it as a moderate recession rather than a short recession. And the unemployment levels get up over 6% is kind of where we've modeled it. So we think we're being fairly conservative, but we reassess that each quarter. So John, I'll hand the deposit question over to you.

[John Woods, Chief Financial Officer]

Yes, sure. And I think some of the trends that you'll likely see into the fourth quarter continue into '23. But I'd say the couple of items I'd highlight are starting with the customer value proposition that you're seeing us continue to invest in. It's been multi-years to build this deposit platform. And in both Consumer and Commercial those investments are coming to fruition and demonstrating themselves that we're continuing to invest. So you're seeing just core deposit growth coming from that. And you heard Brendan and us talk about CitizensPlus as an example of the core growth that we think can give us some unique ability to take some share into '23. Citizens Access and the retail CD arena is a place where we -- we have taken that down close to zero. And so that will come back a bit in that category.

Let's not forget New York Metro. We've entered New York Metro and we're starting to see really nice uptake that once we converted HSBC, we're going to convert ISBC in the first quarter in '23. So we suspect that we're going to start to see some lift coming out of that.

And then just broadly in commercial, the product and coverage investments that we've been making over the years and continue to make will offset what we're building in what I've just described will offset our expectation, we're going to have some DDA migration as rates rise. So that's built into our outlook and built into the NIM guide that we're going to have some realistic expectations of the migration. So it was just some of the areas I would highlight.

[Operator]

Your next question will come from Matt O'Connor with Deutsche Bank.

[Matthew O'Connor, Deutsche Bank]

Some really good detail on credit back in the appendix, Page 24 for retail and 25 on commercial. And obviously, you guys have improved the mix in both areas over the last few years. But are there any signs of weakness within certain kind of customer groups that you could point to? And then like what leading indicators might you suggest that we watch and that you pay attention to.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes, I'll start and then maybe turn it over to my colleagues for some additional color. But Matt, I think what continues to be very positive is that the expectation that things will normalize back to pre-COVID levels continues to be deferred. And so we're only seeing very slow migration in terms of consumer charge-offs and NPAs and delinquencies still kind of better than pre-pandemic period. And I would highlight there that our focus on very high-quality borrowers in these portfolios, super prime and high prime, those folks are still doing pretty well through the current environment and have a lot of liquidity. And so we feel really good about where things sit in Consumer.

Similarly, in Commercial, over time we've migrated to lend to kind of bigger companies, so mid-corporate space companies with in excess of 500 in revenues, and they tend to be more diversified and better credits. And so we also see very solid performance metrics across all the things, NPAs and charge-offs, et cetera.

On that side, you've got to go to the usual suspects, if you think the economy is weakening, and that would be commercial real estate, leveraged lending. And then maybe certain sectors in non-profit, which we've heightened our monitoring in those areas, but we don't see any smoke at this point. So maybe with that, let me turn it to Don for additional color on.

[Don McCree, Head, Commercial Banking]

Yes, I think you hit it. We've actually activated our downturn playbook, which involves a lot of incremental stressing, a lot of incremental portfolio management and a lot of incremental conversations with clients. I think there's a couple of pieces of good news just supporting the lack of deterioration in credit. One is -- we think management teams going through the pandemic, got incredibly focused on efficiency in their business and they cut costs and they automate it and they built liquidity and the repaired balance sheets and they hedged and they did a lot of things that were prudent from a risk standpoint.

So there's a little bit of a buffer, we think, in the portfolio against what could be deterioration if we go into a deep recession. I'd say the thing we're most focused on is the real estate office portfolio given back to work.

We've got fully leased office buildings and those leases are running for a couple of years in the future, but we've got lease rolls that we're focused on and whether they're going to renew or not. I think just personally, I guess I was in New York City yesterday, people are back in the office…

[Bruce Van Saun, Chairman & Chief Executive Officer]

And the other thing is that the high percentage of our office property is A caliber…

[Don McCree, Head, Commercial Banking]

Yes, yes. And then a lot of it's suburban. So it's in the right places. And a lot of it's in places which are in the Southern tier and things like that. So we don't have a lot of San Francisco, for example, where they're going to have -- there's going to be a lot of distress. So MSAs are important in the real estate business. And I think the leverage book is, that you always look at the leverage -- the sponsor leverage for our strategy there, which is high levels of diversification.

Our average hold is kind of $10 million to $12 million. So we do a lot of leverage finance, but we distribute 95% to 97% of it. So -- and we're not really seeing any kind of severe stress in the leverage book. So we feel pretty good. And all the early stats, the crit-class ratios, the nonperforming loans, the watch assets, which we have very significant process around, all seem to be in pretty good shape right now, but we're not…

The other thing I'll mention, and John touched on this, we are being incredibly disciplined on new originations. We're really not taking on any new clients right now. We're getting very focused on returns. We're actually commanding a higher level of pricing given the current market environment. So we're watching the front book very carefully also.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes. How about you, Brendan?

[Brendan Coughlin, Head, Consumer Banking]

Yes. I'd say the health of the consumer is still very, very resilient. Having said that, -- we're doing a lot of the similar things that Don is mentioning, kind of putting in a proactive approach to a potential downturn. So making investments in collections be ready for an inevitable tick in the wrong direction. We're tightening some credit on the margins. We're being incredibly disciplined on where we're lending right now to make sure that the returns are right, and we got real customer relationships, and it's within the risk profile that is within our risk appetite. Having said all that, with what we're seeing kind of out the window today, the consumer is still 20% plus excess liquidity in deposits as a general statement, and charge-offs are still 50% to 60% of the rates that they were pre-COVID, and we're not seeing any meaningful signs of that reinflating.

If you look at the overall U.S. the bottom decile or two of the country, you're starting to see that excess deposits burn off and they're living more paycheck to paycheck, which is where they were pre-COVID. We don't over-index on that segment. And so we index much higher. And so we're not seeing a lot of the pain that is potentially happening at the very bottom of the segment in the U.S. flowing through anything in our book. Look, we're seeing some very, very early signs that potentially were at the early days of a normalization. Credit card customers that pay in full each month. That was about 32% of our portfolio pre-COVID. It's now at 41%. It peaked at 42%. So it's down a tiny bit, but it's still significantly better than what was before COVID.

So we're starting to see small signs of potentially customers getting to, but I wouldn't say it's accelerating at all. It's still very resilient and significantly healthier than where it was pre-COVID.

[Operator]

Your next question will come from the line of Ebrahim Poonawala with Bank of America.

[Ebrahim Poonawala, Bank of America]

Just wanted to follow up one on credit. I think if I heard you correctly that your ACL assumes a 6% unemployment rate. Just I mean, I think CECL is still relatively new. I'm trying to understand, absent that unemployment rate expectations going materially higher. Just if you could give us the thought process around drivers of additional reserve build over the coming quarters? Is it the CRE market? Is it home prices? But what I'm trying to get to is unemployment at 3.5%, 6% seems a long ways away. If that doesn't go much higher, what else would drive those reserves materially higher relative to where we ended the quarter?

[John Woods, Chief Financial Officer]

Yes, I'll go ahead and start there. I mean I think that, first, I'd like to just make sure we're reminded. So we've got 141 basis points against the portfolio right now, when you pro forma adjust that for Investors and some other things, you get a day 1 of about 130. So we're 11 basis points over day 1. So that covers a lot. And so we're covering the environment that Bruce described earlier. I think you could -- and he also mentioned a few pockets of areas that we're watching very closely. So we're watching the CRE office space, and we're watching a few sectors on the C&I side. Just reminding that we're not seeing any -- when you look at where delinquencies are, we're not seeing any early signs of any deterioration here. But that could change, and that could change quickly. So we're keeping a close eye on it.

But -- and as things turn, we'll have those areas of concern that we were focused on in the pandemic, which -- most of which got cleaned out and has been improved over time, but those are -- that's the playbook we'll go back to. We'll go back to those areas of concern and take from there.

[Bruce Van Saun, Chairman & Chief Executive Officer]

I would just add that I think we're feeling pretty good. If you look at a scenario that says we get to a moderate recession and it doesn't get any worse, then the need to actually keep building may lessen from what it was this quarter. I think there was a reassessment, but the Fed is going to have to stay at higher rates, which probably increases the probability of recession a little bit, and that was reflected in going up before basis points.

So you'd have to see even greater conviction that we're likely to hit a recession or the Fed is going to go higher with rates, which is going to have more collateral damage for the need to build on the macro outlook.

Of course, the other things that contribute to higher provision is loan growth. So if we have loan growth and then I think also as John indicated, if we have a kind of changing view on certain sector risks, we already have overlays, for example, for the things we mentioned. We have kind of reserve built for commercial real estate office.

We think that's sufficient, but our view on that could change over time. So I think we're kind of sitting at a pretty good spot now. We'll have to wait and see what happens with the macro forecast in certain sectors and the amount of loan growth that comes through those things would determine whether we have to keep building the reserve and how much. I would say that I think that the concerns that we're going to be building the way we did during the pandemic and oh my gosh, these numbers can be kind of a runaway freight train. We don't see that at all at this point.

So I think those fears are overblown. It's probably one of the reasons that's cast a pall over thanks to valuations. But at this point, we don't see that.

[Ebrahim Poonawala, Bank of America]

That's good color. And just one question, Bruce, on the New York strategy. So once you complete Investors integration first quarter next year, give us a sense of like should we expect like are you adding new bankers? What are the capabilities you're adding to the franchise, just given how huge that market can be in terms of just market share gains, not just for next year, but for the next few years, yes?

[Bruce Van Saun, Chairman & Chief Executive Officer]

Sure. So I'll start, and then maybe I'll ask Don and Brendan to talk about their businesses. But I think that theory has been that we bring a thoughtful approach to how we bank these markets. We really understand neighborhoods. We understand individuals, and we really tailor advice to situations to where somebody is on their life journey kind of where they reside, et cetera.

And on the corporate side, we also want to be that thought leadership position where we're the trusted advisor to a company as its negotiating its many challenges in trying to achieve growth. And we've been able to stake out that ground successfully in the major cities that we compete in. We do it well in Boston. We do it well in Philadelphia, Pittsburgh, some of our other big cities. And so notwithstanding the fact that New York is a relatively crowded and competitive marketplace. We think that our style can be successful in New York. It's going to take a little time. We've bought some good foundational assets. We need to bring our additional kind of culture and approach and bring our broader product set so we can do more for customers and give them more advice and better capabilities, better customer experience, but we think we'll be successful in that over time. So in effect, this is a bet on ourselves. And so far, everything is tracking exactly the way we had expected with little signs of green shoots that we're kind of on to something pretty good.

With that, let me maybe go to Brendan first and talk about the consumer and small business side and kind of where you're making investments and in a view of the future.

[Brendan Coughlin, Head, Consumer Banking]

Yes. We're incredibly pleased with start in New York City post the HSBC acquisition. And as John mentioned, too, we've already started some integration with Investors on mortgage and wealth in New Jersey and some of the borrowers in New York. We're hiring. So we're hiring up investment, financial advisors, mortgage loan officers and business bankers. We're also restacking the retail organization and using talent across the board. And so far, it has really paid dividends. The New York market -- and from a branch network standpoint is the most productive market out of any of our markets so far. Early days, which is an incredibly good early sign. And we're getting a lot of customers coming back to us from some of the big banks, including HSBC customers that enjoyed -- that we didn't buy, but enjoyed the location of the people, and we're really starting to see some growth.

Typically, when you do a branch deposit deal, you see some deposit runoff to the tune of 10% to 20% in the first year. We're actually seeing the opposite. The underlying retail deposit base is actually net growing in New York right away, we didn't have any attrition post legal day 1.

So there's a long way for us to continue to build share and that's early signs, but we're very bullish on what we're seeing so far. And then the Investors franchise, they kind of lead business banking more than consumer and we're excited about that. We think the Investors' capabilities and their distribution can help us accelerate our business banking strategy overall across the franchise. And then when we put our consumer playbook on the investor franchise, we're seeing this big benefit already of HSBC, and they were principally a retail franchise.

When we put that on the Investors franchise that didn't have a meaningful retail presence. The difference from what we bought and what we can build over time is even more substantial. So we're very excited about it. There's still a lot to do, but early signs are very positive.

[Don McCree, Head, Commercial Banking]

I would point at three things. One is the ability, as you said, is to deliver a much broader product set into the existing Investors franchise. So greatly expanded treasury services capabilities, for example, the ability to hedge directly for clients, and that's well underway. And we pick up a lot of very good bankers from the investor side. So our workforce kind of quadruples overnight just with the acquisition. Second thing is we're going to benefit on the commercial side from all the branding that Brendan was doing. So the visibility in New York City of branches and advertising and the like is the name recognition is helpful.

So we don't have to explain what Citizens is to potential new clients. And we are also hiring. We announced yesterday a new Market Head for New York City Metro, which came from JPMorgan. So we've got a new leader in place in New York, and we're off to the races.

[Operator]

Your next question will come from Gerard Cassidy with RBC.

[Gerard Cassidy, RBC Capital Markets]

First, kudos for a very good slide presentation, you guys gave quite a bit of detail. It's one of the best out there. So John, talking about your hedges that you put into place, Slide 23 gives us a good breakout of what you have in place. Can you share with us -- obviously, it's protecting should rates start to go down, I would assume in late '23 and into '24. What kind of rate environment would work against what you just put into place or what you've had in place and you put more into place this quarter? What kind of rate outlook would that -- this would not really work that well with.

[John Woods, Chief Financial Officer]

Yes. I mean, well, let me just start off with I think that the point of getting those hedges on in the third quarter was to allow ourselves to continue to participate in 2023 with rates rising. And so the intent of all of that was to look past this next year into '24 and '25 and say, if in fact, we end up with a lower regime in those years, let's try to find ourselves into a floor that would help maintain the level of ROTCEs that we're trying to achieve. And so we're stabilizing revenues and stabilizing our returns by doing this. Now of course, there's a trade-off.

That trade-off is if rates instead of beginning to come down in '24 they were to remain high or go even higher, that would be an opportunity cost. But nevertheless, on an absolute basis, we've got very attractive returns being locked in through this strategy. And I think that's really what we're trying to achieve.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Gerard, it's tricky. You're trying to find a sweet spot and you're looking at the forward curve and talking to economists, looking at economic forecasts and leaving yourself enough upside participation for high rates, but then also recognizing that they're not going to stay up forever and trying to floor out your downside. And so the time will tell. Hindsight is always 2020. If you went too early or you missed the window, if you had held off another six months because you've gotten better levels. But right now, we feel -- we've done a pretty good job of, as you can see from the results today, we're still asset sensitive. We're still benefiting as rates go up. And now we can sleep at night that we're not going to see ROTCE slide down the pole if rates turn around and go back down.

[Gerard Cassidy, RBC Capital Markets]

Very good. Is it safe to assume all the counterparties or the major global investment banks in these hedges?

[John Woods, Chief Financial Officer]

Yes. Exactly…

[Gerard Cassidy, RBC Capital Markets]

Okay. And then just the second follow-up question. Obviously, you're not an advanced approach bank. And therefore, the AOCI is not an issue with your CET1 ratio, which is the binding constraint for most banks or all banks. When do you think people start to get a little concerned about the tangible common equity ratio, yours are still very healthy. But is there -- do you guys -- I know it's an accounting issue. We all get that. But do you think there will be a concern if to low and do you have any idea what that rate might be? And then second, John, when you accrete the AOCI back into capital as the bonds pay off, do you know about how much will start coming in starting maybe next year in terms of the AOCI coming back into capital?

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes. Maybe I'll just start to say that we did put the TCE to TA ratio into our presentation deck today because we do think it's worth keeping an eye on that. And some folks in the peer group have either have bigger securities portfolio or didn't put as much in HTM and the TCE to TA ratio is sliding quite a bit. Ours is sliding a little bit, but still appears pretty healthy. You could argue that if that's not a regulatory ratio it's not really something to worry about significantly because it will turn around over time. It's just effectively you've got these securities that are going to be earning you less than if you were able to take the cash and reinvest in at today's levels.

So anyway, I think we feel good, we're above 6% in historical times. It's kind of been a marker, and I think we can sustain it there. We have about 30% of the overall portfolio in held to maturity, and we'll have to see where rates go. But if they go up a little bit from here, we're going to continue to generate capital, we think we can keep it at pretty healthy levels.

John, I'll turn it over for you for kind of the turnaround and the rest of the answer.

[John Woods, Chief Financial Officer]

Yes. Great. And just to supplement the earlier one, I mean we've got our health maturity is around 30% right now, it sort of balances that a little bit from -- to that point as well. As it relates to the -- how the AOCI will come back in, if rates kind of move around on us, just the way to think about it, at September 30 we have about $4.5 billion after tax sitting in that number. And that will come in over about five years. So that gives you an ability to work through that, hopefully, too.

[Operator]

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

[Brian Wilczynski, Morgan Stanley]

This is Brian Wilczynski on for Betsy. I was wondering if you could talk a little bit about the expectation to resume buybacks in 4Q and just some of the puts and takes there. You were just talking about capital a moment ago. Obviously, your reg capital position is quite strong today. But at the same time, the macro backdrop is still a bit challenging. So I was just wondering what makes you comfortable at resuming buybacks at this stage.

[Bruce Van Saun, Chairman & Chief Executive Officer]

So we are kind of at the north end of our 9.5% to 10% range. And we indicated we would expect to land there at the end of the year. So I think if you look at our target range relative to peers, we've been a little on a conservative side, which I think, has served us well and particularly going into an environment with a significant amount of uncertainty, that's the position we want to be in.

Having said that, you can see the level of profitability we have now is very significant. So we're generating a huge amount of tangible equity each quarter, this quarter, next quarter. And so we could certainly blow past 10% if we weren't back in the market buying our stock. So I think there's opportunity for us to even improve that ratio a little further and be in the market buying our stock. The wild card often is the amount of balance sheet growth and the amount of -- are there any acquisitions likely in the near term. And I think on that score, we've given you the guidance for what we see for loan growth. So that's factored in.

And then I'd say on the acquisitions, we've really only done very small acquisitions so far this year. We've really been a 100% focus on making sure we're integrating the ones we did last year, we had a pretty better year last year with the New York Metro play and then JMP and DH Capital. And so we focused on integrating. We feel really good about where those are. And so nothing big likely before the end of the year, even just in terms of the fee-based deals that we do. So I think we have the wherewithal to go out and build the ratio a bit further plus get in the market and buy back some stock.

[Operator]

Your next question will come from Ken Usdin with Jefferies.

[Kenneth Usdin, Jefferies]

I know we're getting over an hour. So just a quick one, follow up on Gerard's question. So how through the hedging program do you feel like you are at this point that given what you show us on that grid Slide 23, have you kind of done what you need to do, if not, how much more about you think you need to still add to get that asset sensitivity to the position you really wanted to live in?

[John Woods, Chief Financial Officer]

Yes. I mean I think, this world, there are many things we consider when we work through this. We think about the evolution of the balance sheet where we think rates are going to go, et cetera. But if you look at 3.3%, most of that's on the short end, if you were to say, okay, we know that the Fed's not going to raise rates anymore and you wanted to take that down to neutral, that would mean about $10 billion or $15 billion of additional hedging that would be necessary. And so -- but we're going to be careful and methodical about that and update our balance sheet outlook, update our asset sensitivity, but there's still a significant amount of hedging left to do before we would say that we're done with this cycle.

[Kenneth Usdin, Jefferies]

Okay. And then just a quick follow-up. So John, that point you made in the deck about 4Q '24 NIM floor of 3.25% and down 200 bps. If the Fed does hang high, do you have an idea of what that NIM looks like in a down 100 bps scenario?

[John Woods, Chief Financial Officer]

Yes. I mean, it's somewhere between the two, right? I mean I think it's somewhere between the two. I mean I'd say that, that would be a better outcome for us. And you could expect that, that will be somewhere between the 3.25% and 3.50% bookends that we gave.

[Operator]

Your next question will come from the line of John Pancari with Evercore.

[John Pancari, Evercore ISI]

On the capital markets side of the business, I know you indicated you expect a seasonal increase in the fourth quarter. Could you help us size that up, how do you think about the magnitude there based upon your pipeline?

[Bruce Van Saun, Chairman & Chief Executive Officer]

John, we had a little trouble hearing you.

[Don McCree, Head, Commercial Banking]

Yes, I think, I kind of got it, yes. So John, we've got pipelines bigger than we've ever had on our capital markets side. I think it's important to kind of realize that the place we play is middle market and capital markets. So the most troubled spots to generate revenue in capital markets is these very large M&A deals, which require very large financing. And those are what we are struggling with the market. So we were really pleased that we were able to hold cap markets kind of flat quarter-on-quarter, given all the volatility in the market. And we think most of the action is going to come in M&A. We've got a very big M&A pipeline, a lot of which does not require financing. And it looks like it's moving along quite nicely. So it's not going to double, but we think it could go up $10 million, $20 million in the fourth quarter. But we just have to see, as we go through the quarter, how much volatility and what the backdrop is.

But we're assuming pretty big discounts to the pipeline in terms of what we're forecasting right now. So we're pretty comfortable that we're going to have a good quarter. And then we do think we'll get a -- we'll do a little better now that the currency and interest rate volatility has calmed down a little bit, that hurt us in the third quarter because people weren't really willing to step into the market and hedge. We think we'll do a little bit better on the market business as also in the fourth quarter.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes. And I would just add, so we don't get carried away with Don's sanguine outlook on commercial fees in Q4. When we look at our total fees at top of the house, we'll probably still see a little leakage on mortgage production. The good news here is that servicing is held up very strong, and so our diversification has paid and lend stability to mortgage, but there's probably a slight additional step to take in Q4. And then we did make some changes in our policies regarding overdrafts where we've done away with NSF fees. And so that would clip the service charges line a little bit. So you probably see some strength in commercial offset a bit with a little fall in the consumer side. But overall, we're guiding to the net of that should still be stable to up modestly. And we'll just have to see how much of the capital markets pipeline, as Don said, actually gets printed.

[John Pancari, Evercore ISI]

Okay. Hopefully, you can hear me a little bit better. One last question. Have you sized up the size of the shared national credit portfolio? And then also what percentage of that portfolio are you in the lead position.

[Bruce Van Saun, Chairman & Chief Executive Officer]

Yes. I think the national credit portfolio is a pretty decent size as we've moved up market. But I'd point out a couple of things there is the kind of when you're in shared national credits in general, those are bigger companies that have multi-bank facilities and they tend to be better credits. The second thing is that we continue to migrate towards trying to aim for the left lead position in those shared national credits and/or be one of the book runners or admin agents, so become a meaningful bank to those overall customers. And so that's just been part of our strategy and we're making good traction on that strategy. I think a lot of times investors will think that the shared national credits is a particular point of risk. Our view is that actually that's just part of the strategy, and those are actually good credits. And if you're get to be in the driver's seat of leading the deals, then that's the place you want to be.

[Don McCree, Head, Commercial Banking]

I think that's right. And it's all about return against asset -- against deployment. So underlying the BSO strategy on the commercial side that we talked about in the quarters, we're exiting $1 billion to $2 billion a quarter of under returning assets. A lot of those are shared national credits, which just haven't panned out once we've been a relationship for a couple of years. So that portfolio churns quite aggressively also. And our ability to monetize through the product capabilities that we've built over the last five years is significantly different than it was five years ago, we just got many, many more opportunities to engage and become that lead bank with those clients.

[Bruce Van Saun, Chairman & Chief Executive Officer]

I think that's the end of the queue on the question. So really appreciate everybody's interest and support. Have a great day.

[Operator]

That concludes today's conference call. Thank you for your participation. You may now disconnect.