Citizens Financial Group, Inc. — Q2 2017 Form 10-Q Summary
Business context and reporting period
Citizens Financial Group, Inc. is a bank holding company headquartered in Providence, Rhode Island, operating primarily through Citizens Bank, N.A. and Citizens Bank of Pennsylvania. Its two reportable segments are Consumer Banking and Commercial Banking. The filing covers the three and six months ended June 30, 2017; financial statements are unaudited and prepared under U.S. GAAP.
The company reported $151.4 billion of total assets at June 30, 2017, with approximately 1,200 branches and 3,200 ATMs across 11 states in the New England, Mid-Atlantic and Midwest regions.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Net interest income | $1,026 million | $923 million | 11% |
| Noninterest income | $370 million | $355 million | 4% |
| Total revenue | $1,396 million | $1,278 million | 9% |
| Provision for credit losses | $70 million | $90 million | Down $20 million |
| Noninterest expense | $864 million | $827 million | 4% |
| Net income | $318 million | $243 million | 31% |
| Diluted EPS | $0.63 | $0.46 | 37% |
| Net interest margin | 2.97% | 2.84% | Up 13 bps |
| Efficiency ratio | 61.94% | 64.71% | Improved 277 bps |
| ROTCE | 9.57% | 7.30% | Up 227 bps |
For the first six months, net income was $638 million versus $466 million in the prior-year period, while diluted EPS was $1.24 versus $0.87. First-half revenue increased 11% to $2.780 billion, net interest income increased 11% to $2.031 billion, noninterest income increased 9% to $749 million, and noninterest expense increased 5% to $1.718 billion. First-half ROTCE was 9.62% versus 6.96%.
Balance sheet, credit, debt and liquidity
- Loans and leases were $109.0 billion at June 30, 2017, up $1.4 billion, or 1%, from December 31, 2016. Retail loans increased $1.1 billion, led by education and residential mortgage loans; commercial loans and leases increased $237 million.
- Total deposits were $113.6 billion, up $3.8 billion, or 3%, from year-end 2016. Growth in term deposits, interest-bearing checking, savings and money market accounts more than offset lower demand deposits.
- Short-term borrowed funds declined to $2.4 billion from $4.4 billion at year-end. Long-term borrowed funds increased to $13.2 billion from $12.8 billion, including $2.5 billion of new senior bank debt issued in March and May 2017.
- Cash and cash equivalents were $4.2 billion at June 30, 2017. Six-month operating cash flow was $537 million; investing activities used $1.885 billion and financing activities provided $1.811 billion.
- Contingent liquidity was $28.3 billion, consisting of $3.3 billion of net cash at the Federal Reserve, $18.5 billion of unencumbered high-quality liquid securities and $6.5 billion of unused FHLB capacity. Including approximately $12.5 billion of secured Federal Reserve discount-window capacity, total available liquidity was approximately $40.8 billion.
- The company remained fully compliant with its modified Liquidity Coverage Ratio as of June 30, 2017. The proposed Net Stable Funding Ratio remained under evaluation.
- CET1, Tier 1, total capital and Tier 1 leverage ratios were 11.2%, 11.4%, 14.0% and 9.9%, respectively, unchanged from December 31, 2016 and above applicable regulatory minimums.
- Nonperforming loans and leases were $1.025 billion, or 0.94% of total loans and leases, down from $1.045 billion and 0.97% at year-end. The allowance for loan and lease losses was $1.219 billion, or 1.12% of loans, and covered 119% of nonperforming loans.
- First-half net charge-offs were $162 million, up 9% from $148 million in the prior-year period, although the annualized net charge-off rate remained 0.30%. Commercial criticized loans declined to $2.7 billion, or 5.3% of the commercial portfolio.
Material changes versus the prior comparable period
- Revenue growth was driven by average loan growth and higher loan yields. Average loans increased 6% in Q2 and 7% in the first half, while the net interest margin expanded despite higher deposit and funding costs.
- Noninterest income benefited from capital markets, card, mortgage banking, foreign exchange and letter-of-credit and loan fees. Capital markets fees increased 34% in Q2 and 57% in the first half.
- Operating performance improved, with positive operating leverage of 4.76% in Q2 and 5.79% in the first half. Excluding specified unusual items, underlying operating leverage was 7.43% and 7.14%, respectively.
- Consumer Banking Q2 net income increased 31% to $118 million, while Commercial Banking net income increased 14% to $187 million. First-half net income increased 32% and 24%, respectively.
- The company sold approximately $596 million of lower-return, non-strategic commercial loans and leases during Q2 as part of balance-sheet optimization.
- Average diluted shares declined by approximately 23 million in Q2 and 21 million in the first half, reflecting share repurchases. The company repurchased $260 million of common stock during the first half.
Guidance, outlook, commentary, risks and unusual items
- Management did not provide a full-year earnings or revenue forecast in the provided filing. It indicated that interest rates were expected to increase gradually and that balance-sheet optimization, loan growth and expense management were key performance priorities.
- Q2 results included a $26 million pre-tax impairment related to aircraft lease assets, largely associated with a non-core runoff portfolio. The impairment reduced noninterest income by $11 million and increased noninterest expense by $15 million. Including the impairment, total credit-related costs were $96 million versus $90 million in Q2 2016.
- First-half results included a $23 million benefit from settlement of certain state tax matters, contributing to a 28.8% effective tax rate versus 32.7% in the prior-year period. Excluding this benefit, underlying first-half net income was $615 million and underlying diluted EPS was $1.19.
- Management expects the adoption of the current expected credit loss standard in 2020 to result in earlier recognition of credit losses and an increase in the allowance; the magnitude was not yet determinable.
- Interest-rate risk is material. The balance sheet was asset-sensitive; management estimated that a gradual 200-basis-point increase in rates would increase 12-month net interest income by 5.5%, while a gradual 200-basis-point decline would reduce it by 7.3%. A severe instantaneous 200-basis-point decline would reduce projected net interest income by 11.8%.
- Key risks include adverse economic conditions, higher credit losses, interest-rate and yield-curve changes, deposit pricing pressure, regulatory requirements, litigation and investigations, operational or cybersecurity failures, and the ability to remediate regulatory deficiencies.
- The company remains subject to restrictions on CBNA’s ability to acquire or commence certain financial-subsidiary activities until the OCC completes validation of a remediation plan.
- The company disclosed ongoing litigation, investigations and regulatory matters, including legacy consumer-product and fair-practices matters. Management stated that established reserves and currently known matters were not expected to have a material adverse effect, but potential losses beyond accrued amounts could not be estimated.
- The Federal Reserve did not object to the 2017 capital plan. The plan contemplated quarterly common dividends of $0.18 per share through 2017, $0.22 per share in 2018 and up to $850 million of share repurchases through Q2 2018, subject to capital, earnings, market and regulatory considerations.
Most important facts for an investor to verify
- Whether loan growth and the 2.97% net interest margin can continue as deposit and wholesale funding costs rise.
- The sustainability of credit quality, particularly commercial commodities-related exposures, auto and unsecured retail loans, HELOC resets and the non-core aircraft lease portfolio.
- The recurring earnings impact of the $23 million tax settlement benefit and the $26 million aircraft lease impairment.
- Future allowance requirements, including the effect of CECL adoption and changes in economic forecasts.
- Execution of the approved dividend and share-repurchase plan while maintaining capital ratios above fully phased-in Basel III requirements.
- Progress in addressing regulatory remediation requirements and the potential cost or business impact of litigation, investigations and consent-order matters.
- Liquidity and refinancing needs associated with $13.2 billion of long-term borrowings and scheduled banking-subsidiary maturities.
- The remaining $64.2 billion of off-balance-sheet commitments, including $62.0 billion of undrawn credit commitments and $2.1 billion of financial standby letters of credit.