CITIZENS FINANCIAL GROUP INC quarterly report, Q1 FY2017

Citizens Financial Group, Inc. — Q1 2017 Form 10-Q Summary

Business context and reporting period

Citizens Financial Group, Inc. is a regional bank holding company headquartered in Providence, Rhode Island, operating primarily through Citizens Bank, N.A. and Citizens Bank of Pennsylvania. It serves retail, small-business, commercial, corporate, institutional and not-for-profit customers through approximately 1,200 branches and 3,200 ATMs across 11 states, along with digital and other delivery channels. The company reports Consumer Banking, Commercial Banking and Other activities.

The filing covers the unaudited three months ended March 31, 2017, with comparisons to the three months ended March 31, 2016 and balance-sheet comparisons to December 31, 2016. Total assets were $150.3 billion at March 31, 2017.

Financial performance and key metrics

Metric	Q1 2017	Q1 2016	Change
Net interest income	$1,005 million	$904 million	+11%
Noninterest income	$379 million	$330 million	+15%
Total revenue	$1,384 million	$1,234 million	+12%
Provision for credit losses	$96 million	$91 million	+5%
Noninterest expense	$854 million	$811 million	+5%
Net income	$320 million	$223 million	+43%
Net income available to common stockholders	$313 million	$216 million	+45%
Diluted EPS	$0.61	$0.41	+49%
Net interest margin	2.96%	2.86%	+10 bps
Efficiency ratio	61.68%	65.66%	Improved
Return on average tangible common equity	9.68%	6.61%	+307 bps

Results benefited from 8% average loan growth, higher loan yields, balance-sheet optimization and stronger noninterest income. Capital markets fees increased 92%, foreign exchange and interest-rate products increased 50%, card fees increased 20%, and mortgage banking fees increased 28%.

The effective tax rate was 26.4%, compared with 32.9% in the prior-year quarter. The 2017 rate included a $23 million benefit from the settlement of certain state tax matters and benefits related to the adoption of ASU 2016-09. Excluding the tax settlement, underlying net income was $297 million, underlying diluted EPS was $0.57 and underlying ROTCE was 8.98%.

Balance sheet, credit, debt and liquidity

Loans and leases were $108.1 billion, up modestly from $107.7 billion at December 31, 2016. Education loans increased $632 million and residential mortgages increased $274 million, partly offset by declines in home equity and auto balances.
Total deposits were $112.1 billion, up $2.3 billion, or 2%, from year-end. Average deposits increased 8% year over year to approximately $110.0 billion.
Total securities were approximately $26.0 billion at March 31, 2017, including $25.0 billion of available-for-sale and held-to-maturity securities.
Total liabilities were $130.4 billion and stockholders’ equity was $19.8 billion.
Long-term borrowed funds were $11.8 billion, down from $12.8 billion at year-end. Short-term borrowed funds were $3.9 billion, down from $4.4 billion.
On March 2, 2017, Citizens Bank, N.A. issued $1.0 billion of three-year senior debt, consisting of $700 million of fixed-rate notes and $300 million of floating-rate notes. The increase was more than offset by repayment of long-term FHLB advances.
Net charge-offs were $87 million, compared with $83 million in Q1 2016. The annualized net charge-off rate was 0.33% of average loans.
Nonperforming loans and leases were $1.05 billion, or 0.97% of total loans and leases, broadly unchanged as a percentage of loans. Commercial nonperforming loans increased, primarily due to oil and gas credits, while retail nonperforming loans declined.
The allowance for loan and lease losses was $1.224 billion, or 1.13% of loans, and the total allowance for credit losses, including unfunded commitments, was $1.317 billion.
Regulatory capital remained strong: CET1 was 11.2%, Tier 1 capital was 11.4%, total capital was 14.0% and Tier 1 leverage was 9.9%. Management stated that these ratios were above fully phased-in Basel III minimums plus the capital conservation buffer.
Cash and cash equivalents were $4.0 billion at March 31, 2017, compared with $1.9 billion at March 31, 2016. Contingent liquidity was $27.2 billion, including $19.9 billion of unencumbered liquid securities, $2.5 billion of net cash at the Federal Reserve and $4.8 billion of unused FHLB capacity. Total available liquidity, including secured Federal Reserve discount-window capacity, was approximately $39.0 billion.

Cash flow and capital actions

Operating activities provided $853 million of cash, compared with $374 million in Q1 2016.
Investing activities used $1.143 billion, primarily because of $1.705 billion of available-for-sale securities purchases and a $769 million increase in loans and leases.
Financing activities provided $579 million, reflecting deposit growth and debt issuance, partly offset by repayments of FHLB advances, share repurchases and dividends.
The company paid $72 million of common dividends, paid or declared $7 million of preferred dividends and repurchased $130 million of common stock, or 3,398,478 shares, during the quarter.
The 2017 Capital Plan was submitted to the Federal Reserve on April 5, 2017. Future dividends and repurchases remain subject to regulatory and board approval, capital requirements, financial performance and market conditions.

Material changes versus the prior comparable period

Profitability improved substantially, driven by revenue growth, higher net interest margin, stronger capital markets and card-related income, and a lower effective tax rate.
Commercial Banking net income increased 35% to $180 million, while Consumer Banking net income increased 34% to $95 million.
Expense growth remained below revenue growth, producing positive operating leverage of 6.86 percentage points and reducing the consolidated efficiency ratio by approximately 398 basis points.
Credit costs increased modestly, with higher commercial charge-offs—particularly oil and gas-related—partly offset by improved retail real estate-secured credit performance.
Average diluted shares declined by approximately 19.1 million, reflecting share repurchases and contributing to EPS growth.
The company adopted ASU 2016-09 prospectively. Management stated that the adoption did not materially affect the financial statements, although related tax benefits contributed to the quarter’s tax-rate reduction.
Derivative asset and liability balances declined primarily because of a change in the presentation of variation margin as settlement rather than collateral; this presentation change did not represent an equivalent economic reduction in derivative exposure.

Outlook, management commentary, risks and unusual items

The filing does not provide a specific quantitative earnings, revenue or net-interest-margin guidance forecast. Management emphasized continued loan and deposit growth, expense discipline, technology and franchise investment, and balance-sheet optimization. The balance sheet was described as asset-sensitive; an instantaneous 200-basis-point increase in rates was estimated to increase next-twelve-month net interest income by 11.4%, while a 200-basis-point decline was estimated to reduce it by 11.1%. Actual results may differ as deposit pricing, loan growth, the yield curve and customer behavior change.

Key risks include weaker economic conditions, higher unemployment, housing-market deterioration, increased nonperforming assets and charge-offs, and further normalization of credit losses.
Commercial credit risk was affected by oil and gas exposures, with commercial nonperforming loans and net charge-offs increasing during the quarter.
Interest-rate and yield-curve changes could affect net interest income, funding costs, mortgage originations, mortgage-servicing rights and securities values. The company also faces prepayment risk in its mortgage and HELOC portfolios.
HELOC balances scheduled to enter principal-and-interest repayment during the remainder of 2017 totaled $826 million. The company reported continued mitigation efforts and generally favorable payment performance for prior reset cohorts.
Regulatory risks include capital, liquidity, CCAR/DFAST, consumer compliance, Bank Secrecy Act and anti-money-laundering requirements. CBNA remained subject to restrictions involving new financial subsidiaries pending OCC review and validation of its remediation plan.
Legal and regulatory proceedings may result in settlements, damages, fines, penalties, remediation costs or business restrictions. Management stated that expected aggregate liabilities, after established reserves, were not expected to materially affect the financial statements, but excess exposure could not be estimated for certain matters.
Off-balance-sheet arrangements totaled $64.9 billion, including $62.8 billion of undrawn commitments to extend credit and $1.9 billion of financial standby letters of credit.
The company had a remaining maximum education-loan purchase commitment of $1.2 billion under an agreement covering 2017 purchases. It terminated its automobile-loan purchase agreement in April 2017 after satisfying the final commitment.
The company expects the future current-expected-credit-loss standard to result in earlier credit-loss recognition and an increase in the allowance, although the ultimate impact was still under evaluation.

Important facts for investors to verify

Reconcile reported GAAP net income and EPS with underlying results and isolate the $23 million state-tax settlement benefit.
Monitor commercial credit quality, especially oil and gas exposures, nonperforming loans, criticized loans, net charge-offs and reserve coverage.
Assess whether loan and deposit growth can continue without materially increasing funding costs, credit losses or operating expenses.
Review the effect of further Federal Reserve rate increases, yield-curve changes and deposit repricing on net interest margin.
Track HELOC payment resets, mortgage-servicing-right valuations and mortgage prepayment assumptions.
Confirm the outcome of the 2017 CCAR/DFAST process and any effect on future dividends or share repurchases.
Review regulatory remediation, consumer-compliance matters and legal contingencies, including exposures beyond recorded reserves.
Evaluate implementation effects of the new credit-loss, lease and revenue-recognition standards, particularly the expected allowance increase from the credit-loss standard.