Citizens Financial Group, Inc. — 2018 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2018; comparison period is the three months ended March 31, 2017. The unaudited filing covers a bank holding company with Consumer Banking and Commercial Banking segments. Total assets were $153.5 billion at March 31, 2018.
Financial performance and condition
| Metric | Q1 2018 | Q1 2017 / prior period | Change |
|---|---|---|---|
| Net income | $388 million | $320 million | Up 21% |
| Net income available to common stockholders | $381 million | $313 million | Up 22% |
| Diluted EPS | $0.78 | $0.61 | Up 28% |
| Total revenue | $1.462 billion | $1.384 billion | Up 6% |
| Net interest income | $1.091 billion | $1.005 billion | Up 9% |
| Noninterest income | $371 million | $379 million | Down 2% |
| Provision for credit losses | $78 million | $96 million | Down 19% |
| Noninterest expense | $883 million | $854 million | Up 3% |
| Effective tax rate | 22.5% | 26.4% | Down 3.8 percentage points |
| Net interest margin | 3.16% | 2.96% | Up 20 bps |
| Efficiency ratio | 60.43% | 61.68% | Improved 125 bps |
| Return on average tangible common equity | 11.71% | 9.68% | Up 203 bps |
Balance sheet, credit and capital
- Total assets were $153.5 billion, up from $152.3 billion at December 31, 2017.
- Loans and leases were $111.4 billion, up 1% from year-end. Commercial loans and leases increased 2% to $53.1 billion, while retail loans declined 1% to $58.3 billion.
- Total deposits were $115.7 billion, up 1% from year-end. The consolidated period-end loan-to-deposit ratio was 97.0%.
- Long-term borrowed funds increased to $13.5 billion from $11.8 billion; short-term borrowed funds declined to $1.8 billion from $2.7 billion.
- The allowance for loan and lease losses was $1.246 billion, or 1.12% of loans and leases. Total allowance for credit losses, including unfunded commitments, was $1.332 billion.
- Net charge-offs were $70 million, down 20% year over year; annualized net charge-offs were 0.26% of average loans. Nonperforming loans and leases were $868 million, or 0.78% of total loans and leases.
- Commercial criticized loans increased to $3.5 billion, or 6.5% of the commercial portfolio, from $2.8 billion, or 5.4%, at year-end. Management attributed the increase primarily to restaurant and asset-based lending exposures and stated that reserves were adequate.
- CET1, tier 1, total capital and tier 1 leverage ratios were 11.2%, 11.4%, 13.9% and 10.0%, respectively, broadly unchanged from December 31, 2017 and above applicable regulatory requirements.
Cash flow and liquidity
- Operating activities provided $704 million; investing activities used $1.118 billion, principally from a $1.020 billion net increase in loans and leases; financing activities provided $1.241 billion.
- Cash and cash equivalents increased to $3.859 billion from $3.032 billion at the beginning of the year.
- Contingent liquidity was $30.0 billion, consisting of $19.9 billion in unencumbered high-quality liquid assets, $7.4 billion of unused FHLB capacity and $2.7 billion of cash held at the Federal Reserve.
- The Company reported compliance with the liquidity coverage ratio. Unused secured borrowing capacity was approximately $40.2 billion, including FHLB and Federal Reserve discount-window capacity.
Material changes versus comparable periods
- Earnings growth was driven by higher net interest income, loan growth and a 20-basis-point margin expansion. Higher asset yields and a shift toward higher-yielding loans more than offset rising deposit and funding costs.
- Average loans increased 3% to $111.1 billion and average deposits increased 3% to $113.4 billion.
- Noninterest income declined because capital markets fees fell $9 million from near-record Q1 2017 levels and other income declined $7 million. Mortgage banking fees increased $2 million.
- Expenses increased due to merit increases, stock-based compensation, revenue-related incentives, software amortization and strategic investment, particularly in Consumer Banking.
- Credit costs improved because of lower commercial losses, although the quarter included an $8 million reserve build and higher expected seasoning in retail portfolios.
- The effective tax rate benefited from U.S. tax reform. Q1 2017 also included a $23 million benefit from the settlement of certain state tax matters; excluding that item, Q1 2018 underlying net income increased 31% and underlying diluted EPS increased 37%.
- The Company repurchased $175 million of common stock and paid $108 million of common dividends, or $0.22 per share, versus $130 million of repurchases and $72 million of common dividends in Q1 2017.
- First-quarter 2018 adoption of revenue-recognition, pension-cost presentation and financial-instrument standards did not materially affect net income. Revenue-recognition adoption changed certain presentation items but did not change the timing or amount of revenue recognized.
Guidance, outlook, risks and unusual items
- The filing does not provide a specific quantitative full-year earnings or revenue forecast. Management states that interim results are not necessarily indicative of the full year.
- Management described the Company as asset-sensitive: a gradual 200-basis-point increase in rates was estimated to increase next-12-month net interest income by 5.0%, while a gradual 100-basis-point decrease was estimated to reduce it by 1.6%.
- Interest-rate risk includes potential pressure from deposit repricing and funding costs, mortgage prepayments, securities valuations and mortgage-servicing-right values. The fair value of mortgage servicing rights was $246 million versus a $201 million carrying value.
- HELOC exposure requires monitoring: the $13.3 billion portfolio included $700 million scheduled to reset into repayment during the remainder of 2018 and $2.7 billion scheduled to reset between April 2018 and December 2021.
- Commercial criticized loans increased materially, although management stated that the affected loans were generally well secured and did not have high loss content.
- Key risks include economic deterioration, housing and employment weakness, credit losses, interest-rate and liquidity changes, deposit pricing, regulatory and supervisory requirements, litigation, cybersecurity and operational failures.
- The Company submitted its 2018 capital plan and stress-test results to the Federal Reserve on April 5, 2018. Future dividends and repurchases remain subject to regulatory, capital, financial and market conditions.
- On May 7, 2018, the Company applied to consolidate its banking subsidiaries through a merger of Citizens Bank of Pennsylvania into Citizens Bank, National Association, with a targeted January 2019 completion subject to regulatory approval.
- The filing reports ongoing litigation and regulatory matters but states that management believes aggregate potential liabilities, based on currently available information and established reserves, will not materially adversely affect the financial statements. The filing does not provide a clear aggregate exposure value.
- Current expected credit-loss guidance is scheduled for adoption on January 1, 2020. Management expects earlier recognition and a higher allowance, but the quantitative effect could not yet be reasonably estimated.
Investor verification checklist
- Verify sustainability of the 3.16% net interest margin as deposit and wholesale funding costs rise.
- Monitor commercial criticized loans, restaurant and asset-based lending exposures, charge-offs and reserve adequacy.
- Track HELOC repayment resets, auto and unsecured retail performance, and nonperforming assets.
- Reconcile reported GAAP results with underlying non-GAAP comparisons, particularly the $23 million Q1 2017 tax settlement benefit.
- Assess capital-plan approval, future dividend and repurchase capacity, and the effect of risk-weighted-asset growth.
- Review liquidity coverage, FHLB reliance, debt maturities and the impact of any credit-rating changes.
- Evaluate the eventual impact of the expected-credit-loss standard and the proposed bank-subsidiary consolidation.