Citizens Financial Group, Inc. — 2Q16 Form 10-Q Summary
Business context and reporting period
Citizens Financial Group, Inc. is a bank holding company operating primarily through Citizens Bank, N.A. and Citizens Bank of Pennsylvania. It provides consumer and commercial banking services through approximately 1,200 branches and 3,200 ATMs in 11 states. The filing covers the unaudited three and six months ended June 30, 2016, compared primarily with the corresponding 2015 periods, and the balance sheet compared with December 31, 2015.
Key financial metrics
| Metric | Three months ended June 30, 2016 | Six months ended June 30, 2016 |
|---|---|---|
| Net interest income | $923 million | $1.827 billion |
| Noninterest income | $355 million | $685 million |
| Total revenue | $1.278 billion | $2.512 billion |
| Provision for credit losses | $90 million | $181 million |
| Noninterest expense | $827 million | $1.638 billion |
| Net income | $243 million | $466 million |
| Net income available to common stockholders | $243 million | $459 million |
| Diluted EPS | $0.46 | $0.87 |
| Net interest margin | 2.84% | 2.85% |
| Efficiency ratio | 64.71% | 65.18% |
| Return on average tangible common equity | 7.30% | 6.96% |
At June 30, 2016, total assets were $145.2 billion, loans and leases were $103.6 billion, deposits were $106.3 billion, total liabilities were $125.0 billion, and stockholders’ equity was $20.2 billion. Long-term borrowed funds were $11.8 billion and short-term borrowed funds were $3.5 billion.
First-half operating cash flow was $704 million. Investing activities used $5.6 billion, primarily because of a $5.0 billion increase in loans and leases and $2.4 billion of available-for-sale securities purchases. Financing activities provided $5.5 billion, including $3.7 billion of deposit growth and $7.0 billion of long-term borrowing proceeds, partially offset by debt repayments. Cash and cash equivalents ended at $3.7 billion.
Regulatory capital remained strong: the Basel III transitional CET1 ratio was 11.5%, the Tier 1 capital ratio was 11.7%, the total capital ratio was 14.9%, and the Tier 1 leverage ratio was 10.3%. Management reported full compliance with the liquidity coverage ratio through June 30, 2016. Contingent liquidity was $23.2 billion, including $17.0 billion of unencumbered liquid securities, $2.7 billion of net overnight cash, and $3.5 billion of unused FHLB capacity; available Federal Reserve discount-window capacity was $11.7 billion.
Material changes versus prior comparable periods
- Second-quarter net income increased 28% to $243 million from $190 million; first-half net income increased 17% to $466 million from $399 million.
- Net interest income increased 10% in the quarter and 9% in the first half, supported by 7% average loan growth, deposit growth, improved loan yields, and higher net interest margins. Average deposits increased 6% in the quarter and 7% in the first half.
- Noninterest income declined 1% in the quarter and 3% in the first half. Higher service charges and capital markets fees were offset by lower mortgage banking, card, securities, foreign exchange, and other income.
- Reported noninterest expense declined 2% in the quarter and 1% in the first half, primarily because 2015 included restructuring charges and special items. Excluding those items, expense increased $26 million in the quarter and $37 million in the first half, driven mainly by salaries, benefits, software amortization, and certain operating costs.
- The credit-loss provision increased to $90 million in the quarter from $77 million, reflecting a $25 million reserve build versus a $1 million release in 2015. The first-half provision increased to $181 million from $135 million and included a $33 million reserve build.
- Loans and leases increased 5% from year-end 2015, led by commercial loans and commercial real estate, student loans, and residential mortgages. Home equity balances declined.
- Nonperforming loans and leases were $1.044 billion, or 1.01% of total loans and leases, versus 1.07% at year-end 2015. Commercial nonperforming loans increased to $347 million from $148 million, primarily because of higher oil and gas industry nonperforming loans, while retail nonperforming loans declined.
- Net charge-offs were $65 million in the quarter, down from $78 million in 2015, but $148 million for the first half, up from $132 million. The allowance for loan and lease losses was $1.246 billion, or 1.20% of loans, compared with 1.23% at year-end 2015.
- The Company migrated to a vendor-based model for estimating securities impairment in June 2016. The change produced a one-time adjustment contributing to higher securities impairment losses, which were $8 million for the first half versus $3 million in 2015.
Guidance, outlook, commentary, risks, and unusual items
The Federal Reserve did not object to the Company’s 2016 capital plan. The plan contemplated quarterly common dividends of $0.12 per share through 2016, a potential increase to $0.14 per share in 2017, and up to $690 million of share repurchases through the second quarter of 2017. These actions remained subject to Board approval, capital conditions, earnings, liquidity, market conditions, and regulatory requirements.
Management characterized the U.S. economy as expanding slowly amid low interest rates and noted that the Company remains asset-sensitive to interest rates. An instantaneous 200-basis-point rate increase was estimated to increase next-twelve-month net interest income by 14.0%, while an instantaneous 200-basis-point decline was estimated to reduce it by 4.8%. These are model-based sensitivities and exclude potential management actions.
Approximately $3.4 billion, or 23%, of the $14.7 billion HELOC portfolio was subject to a payment reset or balloon payment between July 1, 2016 and December 31, 2018. Management reported favorable performance to date but identified payment shock, housing values, unemployment, interest rates, credit quality, and loss severity as important risks.
Commercial nonperforming loans increased because of oil and gas exposures and new negative guidance concerning multi-tiered debt structures. Other significant risks include regulatory remediation, litigation and investigations, consumer compliance, cybersecurity and operational failures, funding and liquidity conditions, market volatility, mortgage servicing-rights valuation, and potential goodwill impairment.
Legacy regulatory consent orders relating to checking and funds-transfer products, deposit reconciliation, identity theft, and debt-cancellation products remained in effect. Financial penalties had been paid, and substantially all related remediation was expected to be resolved by the end of 2016. CBNA also remained subject to restrictions on acquiring or expanding financial subsidiaries until the OCC was satisfied with its remediation plan.
Subsequent events included the July 19, 2016 sale of $310 million of consumer real-estate-secured TDR loans, expected to generate an approximately $70 million pretax gain in the third quarter; a July 20 declaration of a $0.12 quarterly common dividend; and the July 28 issuance of $350 million of senior notes used with available cash to repurchase $500 million of subordinated notes held by RBS.
Most important facts for investors to verify
- Whether commercial credit deterioration, particularly in oil and gas, leads to additional provisions, charge-offs, or reserve increases.
- The performance of HELOC borrowers as scheduled payment resets continue through 2018.
- The recurring expense base after excluding 2015 restructuring and special items, and whether planned efficiency initiatives offset ongoing technology, compliance, and personnel costs.
- The sustainability of loan and deposit growth and the benefit of higher rates to net interest margin amid continued low long-term rates.
- The realized gain and related expenses from the third-quarter 2016 TDR transaction.
- The effect of the July 2016 debt refinancing and RBS note repurchase on interest expense, capital, and liquidity.
- The status and cost of regulatory remediation, including the OCC restriction concerning CBNA’s financial subsidiaries.
- Future credit-loss impacts from the new expected-credit-loss accounting standard, effective for the Company beginning January 1, 2020; the filing states that the impact was still under assessment.