Citizens Financial Group, Inc. — 2018 Q3 Form 10-Q Summary
Business context and reporting period
Citizens Financial Group is a bank holding company headquartered in Providence, Rhode Island, serving consumer, small-business, middle-market, corporate and institutional customers through Consumer Banking and Commercial Banking. The unaudited filing covers the three and nine months ended September 30, 2018, with comparisons to the corresponding 2017 periods. Total assets were $158.6 billion at September 30, 2018.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net income | $443 million | $348 million | $1,256 million | $986 million |
| Net income available to common stockholders | $436 million | $341 million | $1,242 million | $972 million |
| Diluted EPS | $0.91 | $0.68 | $2.57 | $1.92 |
| Total revenue | $1,564 million | $1,443 million | $4,535 million | $4,223 million |
| Net interest income | $1,148 million | $1,062 million | $3,360 million | $3,093 million |
| Noninterest income | $416 million | $381 million | $1,175 million | $1,130 million |
| Provision for credit losses | $78 million | $72 million | $241 million | $238 million |
| Noninterest expense | $910 million | $858 million | $2,668 million | $2,576 million |
| Effective tax rate | 23.2% | 32.2% | 22.8% | 30.0% |
| Net interest margin | 3.19% | 3.05% | 3.18% | 3.00% |
| Efficiency ratio | 58.2% | 59.4% | 58.8% | 61.0% |
| ROTCE | 13.3% | 10.1% | 12.6% | 9.8% |
Average loans and leases increased 4% year over year to $114.0 billion in the third quarter, while average deposits increased 4% to $117.0 billion. At period end, loans and leases were $114.7 billion, deposits were $117.1 billion and the allowance for loan and lease losses was $1.2 billion. The total allowance for credit losses, including unfunded commitments, was $1.3 billion.
Asset quality remained generally strong. Nonperforming loans and leases declined to $832 million, or 0.73% of total loans and leases, from $871 million, or 0.79%, at December 31, 2017. Net charge-offs were $86 million in the third quarter and $232 million for the first nine months. Commercial criticized loans and leases increased 8% from year-end to $3.1 billion, primarily because of heightened monitoring of general restaurant portfolio loans.
Cash provided by operating activities was $1.2 billion for the first nine months. Investing activities used $5.1 billion, primarily for loan growth, securities purchases and the FAMC acquisition. Financing activities provided $4.8 billion, primarily through long-term borrowings, deposit growth and preferred-stock issuance. Cash and cash equivalents ended the period at $4.0 billion, compared with $2.1 billion at September 30, 2017.
Long-term borrowed funds increased to $15.6 billion from $11.8 billion at December 31, 2017, mainly due to higher Federal Home Loan Bank advances. Total short-term borrowed funds were $2.4 billion. The company reported $25.7 billion of contingent liquidity, $22.0 billion of asset liquidity and approximately $36.3 billion of unused secured borrowing capacity. Citizens stated that it remained compliant with the Liquidity Coverage Ratio.
Regulatory capital remained above minimum requirements: CET1 was 10.8%, Tier 1 capital was 11.2%, total capital was 13.4% and Tier 1 leverage was 9.9% at September 30, 2018. The CET1 ratio declined from 11.2% at year-end, reflecting risk-weighted-asset growth, the FAMC acquisition, dividends and $725 million of common-stock repurchases.
Material changes versus prior comparable periods
- Third-quarter net income rose 27% and diluted EPS rose 34%, supported by 8% revenue growth, higher net interest margin and a lower tax rate.
- Nine-month net income rose 27% and diluted EPS rose 34%; net interest income grew 9% and total revenue grew 7%.
- Higher rates and a shift toward higher-yielding assets increased net interest margin, although deposit and funding costs also rose materially.
- Noninterest income benefited from mortgage banking activity associated with the Franklin American Mortgage Company acquisition; mortgage banking fees increased $22 million year over year in the third quarter.
- Noninterest expense increased 6% in the third quarter and 4% for the nine months, including $25 million of FAMC operating costs and $9 million of FAMC integration costs.
- Net charge-offs increased 32% year over year in the third quarter, primarily because of lower commercial recoveries and seasoning in unsecured retail and education portfolios.
- Capital and liquidity were supported by a $300 million Series B preferred-stock issuance, $725 million of common-stock repurchases and increased wholesale borrowing.
Guidance, outlook, commentary, risks and unusual items
Management did not provide a conventional quantitative earnings forecast in the filing. The approved 2018 capital plan increased the quarterly common dividend to $0.27 in the third quarter, contemplated a potential increase to $0.32 beginning in 2019, and authorized up to $1.02 billion of common-stock repurchases through the second quarter of 2019. Future distributions remain subject to capital, earnings, liquidity, regulatory and market conditions.
On August 1, 2018, Citizens acquired certain FAMC assets and liabilities for total consideration of $582 million, including mortgage servicing rights with an acquisition-date fair value of $590 million, $59 million of goodwill and $32 million of other intangibles. FAMC generated additional mortgage banking revenue but also increased operating and integration costs.
Other notable items included $7 million after-tax of FAMC integration costs in the third quarter and first nine months of 2018. The first nine months of 2017 included a $23 million state-tax settlement benefit and $26 million of aircraft lease impairments. “Underlying” results are non-GAAP measures and should be evaluated with the comparable GAAP results.
Citizens received approval to merge Citizens Bank of Pennsylvania into Citizens Bank, National Association, with the consolidation planned for January 2019 to streamline governance, risk management and operations. The company also announced after quarter-end an agreement to acquire Clarfeld Financial Advisors.
Principal risks include economic and political deterioration, housing and employment weakness, higher credit losses, interest-rate and deposit-cost pressure, market-liquidity changes, regulatory and supervisory requirements, litigation and investigations, cybersecurity and operational failures, capital and liquidity constraints, mortgage servicing-rights valuation risk, and the potential effect of the future Current Expected Credit Loss standard. Management expects CECL adoption to increase the allowance for credit losses, but the amount could not yet be reasonably estimated.
As of September 30, 2018, the company had $68.9 billion of off-balance-sheet arrangements, including $66.7 billion of undrawn commitments to extend credit. Management stated that existing legal and regulatory matters were not expected to have a material adverse effect, although ultimate outcomes and timing cannot be predicted with certainty.
Investor verification items
- Reconcile GAAP results with management’s non-GAAP “Underlying” measures, particularly the treatment of FAMC integration costs and 2017 unusual items.
- Monitor deposit pricing, funding costs and net interest margin as interest rates and deposit competition evolve.
- Review commercial criticized loans, retail seasoning, HELOC resets and net charge-off trends for evidence of emerging credit deterioration.
- Assess the effect of FAMC integration, mortgage servicing-rights valuation and the planned bank-subsidiary merger on expenses, capital and operating efficiency.
- Verify execution of the approved dividend and repurchase plan against capital ratios, regulatory conditions and market conditions.
- Evaluate the eventual CECL adoption impact, which the filing states could increase the allowance for credit losses but does not quantify.
- Review the company’s liquidity buffer, FHLB dependence, debt maturities and contingent borrowing capacity under stressed conditions.