Good morning, everyone, and welcome to the Citizens Financial Group third quarter 2022 earnings conference call. My name is Alan, and I'll be your operator today. Currently, all participants are in a listen-only mode. Following the presentation, we will conduct a brief question and answer session. As a reminder, this event is being recorded. Now I'll turn the call over to Kristin Silberberg, Executive Vice President, Investor Relations. Kristin, you may begin.
Thank you, Alan. Good morning, everyone, and thank you for joining us. First this morning, our Chairman and CEO, Bruce Van Saun, and CFO, John Woods, will provide an overview of our third quarter results. Brendan Coughlin, Head of Consumer Banking, and Don McCree, Head of Commercial Banking, are also here to provide additional color. We will be referencing our third quarter earnings presentation located on our investor relations website. After the presentation, we will be happy to take questions. Our comments today will include forward-looking statements which are subject to risks and uncertainties that may cause our results to differ materially from expectations. These are outlined for your review on page two of the presentation. We also reference non-GAAP financial measures, so it's important to review our GAAP results on page three of the presentation and the reconciliations in the appendix. With that, I will hand over to Bruce.
Okay, thanks, Kristin. Good morning, everyone. Thanks for joining our call today. We delivered another very strong quarterly result in Q3. Rising rates positively impacted our net interest income and net interest margin. Fees and expenses were broadly stable and credit performance remains excellent. We grew average loans 2% and deposits 1% as our liquidity and funding position remains strong and our CET1 ratio of 9.8% is above the midpoint of our 9.5%-10% target range. Our TCE-to-total asset ratio sits at 6.1%. Performance metrics include a net interest margin of 3.25%, and that's up 21 basis points. We had positive sequential operating leverage of 6%. We had hit an efficiency ratio below 55% and our return on tangible common equity was around 18%.
We built our credit reserves by $49 million with our ACL at 1.41%, and that's above the 1.3% day one CECL reserve adjusted for the Investors acquisition. Beyond these impressive financial results, we've continued to make good progress in executing our strategic initiatives. In consumer, we launched Citizens Private Client, which will help drive wealth opportunities. We migrated our national digital bank to a modern cloud-based platform. We continue to grow share with Citizens Pay, and we're executing well on our expansion into New York City metro region. In commercial, we've successfully integrated recent acquisitions like JMP and DH Capital into our coverage and product model. Our M&A pipelines are at record levels and our geographic and industry vertical build-out is delivering strong results in terms of market share gains.
Enterprise-wide, we're successfully wrapping up our TOP VII program while building out TOP VIII. Stay tuned on that. Our Next Gen Tech program has really been the standout initiative that has been a game changer for us. These programs demonstrate our mindset of continuous improvement, finding ways to run the bank more efficiently so we can deliver positive operating leverage and self-fund investments for our future. We're also doing some interesting things in ESG, such as developing a carbon offset program for clients, as well as investing in a virtual power agreement that delivers clean energy. We have more interesting innovation in the pipeline. As we look forward to Q4 and 2023, we feel that we are well-positioned to deliver strong results and to keep growing and enhancing our franchise value.
We are well prepared for challenges that may materialize in the macro environment with a really strong balance sheet position and highly prudent credit risk appetite. We also plan to keep playing disciplined offense with continuing investments in our growth initiatives. The current environment gives us a great opportunity to prove our mettle and deliver responsible, sustainable growth. One aspect that we emphasize in today's presentation is our confidence in the quality of our deposit base that we've been able to transform over time. We've had good deposit stability over the past couple of quarters, as some peers are seeing outflows, and our deposit betas are back in line with the pack. We're seeing very strong loan betas and expect these to remain above deposit betas through 2024, assuming the current forward curve. As a result, our NIM will continue to rise more gradually as time goes on.
We've also layered in sizable net interest rate hedges to protect NIM and ROTCE through 2024 if the Fed reverses and brings down short-term rates. Moving off of the zero bound for short rates has unlocked the value of our deposit franchise and significantly benefited our ROTCE. With a clearer macro outlook and less market volatility, we feel the value of our commercial bank build out will also manifest, benefiting further our ROTCE. Very exciting time for Citizens. With that, I'll stop and turn it over to John to cover the financials in more detail. John?
Thanks, Bruce, and good morning, everyone. First, I'll start with our headlines for the quarter, referencing slide five. We reported underlying net income of $669 million and EPS of $1.30.
Our underlying ROIC for the quarter was 17.9%. Net interest income was up 11% linked quarter, driven by a 21 basis points improvement in margin to 3.25% and 2% growth in average interest-earning assets. Average loans are up 2% linked quarter with 3% growth in commercial. Fees were fairly stable, down 2% linked quarter as our client hedging business returned to more historical levels following an exceptional first half of the year, and mortgage results softened a bit. Capital markets fees and service charges were stable. We remain highly disciplined on expenses, which are up 1% linked quarter. Overall, we delivered underlying positive operating leverage of 6% linked quarter and our underlying efficiency ratio improved to 54.9%.
We recorded a provision for credit losses of $123 million and a reserve build of $49 million this quarter, which reflects an increased risk of recession, partly offset by improvement in portfolio mix. Our ACL ratio stands at 1.41%, up from 1.37% at the end of the second quarter, and compares with a pro forma day one CECL reserve of approximately 1.3%. Our tangible book value per share is down 8.6% linked quarter, driven by the impact of higher long-term rates on AOCI. We continue to have a very strong capital position with our CET1 ratio at 9.8% just above the midpoint of our target range. Next, I'll provide further details related to third quarter results.
On slide six, net interest income was up 11% given higher net interest margin and 2% growth in interest earning assets. The net interest margin is 3.25%, up 21 basis points. As you can see on the NIM walk in the bottom left-hand side of the slide, the healthy increase in asset yields outpaced funding costs, reflecting the asset sensitivity of our balance sheet. Moving to slide seven. With the current expectation for the Fed to raise rates further, we are confident that we will continue to realize meaningful benefits from rising rates as the forward curve plays out. Our asset sensitivity has driven a significant improvement in NII year to date, and those benefits will continue to accumulate into the fourth quarter and compound into 2023.
Our overall asset sensitivity increased to approximately 3.3% at the end of the third quarter, up from 2.6% for the second quarter, primarily driven by the impact of variable rate loan originations. Our asset sensitivity will allow us to have further upside if the forward curve continues to move up. We expect cumulative loan betas to exceed deposit betas through the rate cycle. Our interest-bearing deposit beta is tracking well within our expectations, and the ultimate outcome will depend upon the pace and level of Fed rate hikes from here. So far this cycle, with Fed funds increasing 225 basis points since 4Q2021, our cumulative interest-bearing deposit beta is well controlled at 18% through the end of the third quarter. On a sequential basis, our deposit beta was 26%.
We began the rate cycle with a strong liquidity and funding profile, including significant improvements through our deposit mix and capabilities. We will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits. We continue to execute our hedging strategy to manage a more predictable and stable outlook for NII as we benefit from the higher rate environment. You'll find a summary of our hedge position in the appendix on slide 23. In the third quarter, we did an additional $10 billion of hedges with a focus on extending our protection out through 2024 and beyond, primarily through forward starting swaps.
We expect our NIM to rise to 3.5% or better by the end of 2023, and for our overall hedge position to provide a NIM floor of about 3.25% through the fourth quarter of 2024 if we see rates come down by 200 basis points across the forward curve. The floor could move higher with further hedge actions. Moving on to slide eight. We posted good fee results despite headwinds from continued market volatility and higher rates. Fees were fairly stable, down 2% linked quarter as our client hedging business returned to more historical levels following an exceptional first half of the year. Card fees were strong again this quarter while capital markets and service charges were stable. Focusing on capital markets, market volatility continued to impact the bond and equity markets.
M&A advisory fees picked up nicely, but this was offset by lower loan syndication revenue amid increased economic uncertainty and market volatility. We continue to see good strength in our M&A pipelines, which continue to build with strong pitch activity and a growing backlog while current markets settle down. Mortgage fees were softer as the higher rate environment weighed on production volumes, which more than offset the fact that production margins improved modestly this quarter but still remain below historical levels. We are seeing signs of the industry reducing capacity, which should benefit margins over time, and servicing operating fees were stable. Wealth fees are $5 million lower linked quarter, given the impact of lower market levels on AUM. In other income, we saw a seasonal benefit from our tax-advantaged investments and an increase in leasing revenue.
On slide nine, expenses were well controlled, up 1% linked quarter. Our TOP VII efficiency program is continuing to make good progress and is on track to deliver over $115 million of pre-tax run rate benefits by the end of the year. Average loans on slide 10 were up 2% linked quarter, driven by 3% growth in commercial, with growth in C&I and CRE given modestly higher line utilization and slower paydowns. Retail loans increased 1% with growth in mortgage and home equity, offsetting planned runoff and auto. Period end loans were broadly stable linked quarter, given higher than usual end of quarter C&I line paydown, which were generally redrawn after quarter end.
On slide 11, average deposits were up $1.3 billion or 1% linked quarter, with growth coming from retail term deposits and Citizens Access Savings and commercial banking deposits were broadly stable. Deposit costs remain well controlled. Our interest-bearing deposit costs were up 38 basis points, which translates to an 18% cumulative beta. We feel good about how we are optimizing deposit costs in this rate environment, and our performance to date is reflective of the investments made to strengthen our deposit franchise since the IPO. Overall liquidity improved as we reduced our FHLB advances by $2.3 billion and increased our cash position at quarter end. Moving on to slide 12. We saw good credit results again this quarter across the retail and commercial portfolios.
Net charge-offs were 19 basis points, up 6 basis points linked quarter, but still very low relative to historical levels. Non-performing loans were broadly stable at 55 basis points of total loans. Given the higher risk of recession, we are watching our loan portfolio very carefully for early signs of stress, in particular, CRE office, leveraged loans, and selected nonprofit sectors. At this point, we aren't seeing significant issues emerge. Also, the leading indicators for consumer continue to be stable and favorable to pre-pandemic levels. Personal disposable income has declined from stimulus-driven highs but remains above the pre-pandemic 2019 average. Spending for travel and restaurants remains steady and above pre-pandemic levels, while credit card and home equity line utilization are still well below pre-pandemic levels. Retail delinquencies continue to remain favorable to historical levels. Turning to slide 13, I'll walk through the drivers of the allowance this quarter.
We continue to see very good credit performance across the retail and commercial portfolios. While we aren't seeing stress in the portfolio at this point, we increased our allowance by $49 million to take into account an increased risk of recession, partly offset by improvement in portfolio mix. Our overall coverage ratio stands at 1.41%, which is a modest increase from the second quarter. If you recall, when we adopted CECL at the beginning of 2020, our coverage ratio was 1.47%. However, given the Investors acquisition and some shifts in the portfolio mix, we estimate our pro forma day one CECL allowance to be approximately 1.3%.
The current reserve level contemplates a shallow recession and incorporates the risk of added stress on certain portfolios, including those subject to higher risk from inflation, supply chain issues, and return to office trends. Moving to slide 14, we maintained excellent balance sheet strength. Our CET1 ratio increased to 9.8%, which is slightly above the midpoint of our target range. This, combined with our strong earnings outlook, puts us in a position to resume share repurchases in the fourth quarter. Tangible book value per share and the tangible common equity ratios were both reduced by the impact of higher long-term rates on AOCI. We have increased our held to maturity portfolio to about 30% of total loans at quarter end, which has helped to mitigate the impact of rising rates.
Our fundamental priorities for deploying capital have not changed, and you can expect us to remain extremely disciplined in how we manage capital allocation. Shifting gears a bit, on slides 15 and 16, you'll see some examples of the progress we've made against the key strategic initiatives and what's on tap for our businesses in the near term. Since we closed the Investors acquisition in April, we've been executing against a phased approach to the integration. In the second quarter, we began originating mortgages on our systems, and since then, we have completed the conversion of mortgage servicing. We also successfully completed the conversion of more than 10,000 Investors wealth clients, representing about $1.6 billion in assets to our platform.
We have a lot more to do, but I'm pleased to say that we are on track to complete the deposit and branch conversions in mid-first quarter 2023. We have included a high-level integration timeline in the appendix on slide 22. Importantly, we remain on target to achieve our planned $130 million in run rate net expense synergies by the end of 2023, all of which approximately 70% will be achieved by the end of 2022. We also continue to expect that the integration costs will come in below our initial estimates. In the last few years, we have launched a collection of new banking products and features that make it easier to bank with us.
Last week, we announced the next step in that evolution with CitizensPlus, which provides financial rewards, banking features, and tailored advice that grows with customers from everyday banking to personalized wealth management. This includes Citizens Private Client, our new expanded wealth management offering, which will launch by the end of the year. We are fully committed to driving momentum in our wealth business, and as part of the launch, we are hiring more than 200 new financial advisors and relationship managers. We continue to make meaningful strides forward with our national digital strategy and tech modernization. Earlier this year, we migrated Citizens Access to a fully cloud-enabled platform, and we launched a national storefront adding mortgage and education refis to the portal. Over the next year or so, we plan to expand our national storefront, adding card and checking first, and then wealth and Citizens Pay.
As we add products to the platform, we have an exciting opportunity to build relationships across a growing national customer base. Our vision is to migrate our core branch deposits to this modern platform over time, which will be a sea change in efficiency and flexibility in terms of implementing upgrades and enhancements. We are also growing our innovative Citizens Pay offering, which is currently at about 160 merchant partners and expanding across targeted verticals. Over the next year, we are working to launch a new mobile app and a unique customer direct experience. Moving to the commercial business on slide 16. Over the past eight years, we've invested heavily in talent and product capabilities in M&A, corporate finance, bond and equity underwriting, FX and commodities, and so on.
Despite the challenging environment, we remain near the top of the league tables, consistently ranking in the top 10 as a middle market and sponsor book runner and helping corporates and private equity sponsors access capital through the public markets. We have also integrated our cash management and global market solution as well with our coverage. We are excited about the potential synergies from our recent acquisitions as we target growth in key verticals. The JMP acquisition gets us much deeper into the growing healthcare technology and financial services sectors, expands our equity underwriting, and adds research capabilities. DH Capital expands our capabilities in the internet infrastructure, communication sectors, software, and next-generation IT services. These businesses are exceptionally well positioned for when markets reopen. Moving to slide 17, I'll walk through the outlook for the fourth quarter.
We expect NII to be up roughly 3% driven by the benefit of higher rates with a margin rising to the 3.3%-3.35% range. Average loans are expected to be stable to up modestly as commercial growth is partially offset by auto rundown. Fees are expected to be stable to up modestly. Non-interest expense is expected to be stable. Net charge-offs are expected to be approximately 20-22 basis points. We expect our CET1 ratio to land near the upper end of our target range of 9.5%-10%. Our tax rate should come in at approximately 22%. With respect to the full year, we continue to track well and expect to beat our full year 2022 guides across key P&L categories and performance measures.
We expect to deliver positive operating leverage for full year 2022 in excess of 5% with fourth quarter sequential positive operating leverage of about 3%. We also expect to deliver a full-year efficiency ratio of about 57%, with the fourth quarter coming in under 54%. We expect to deliver a full-year ROTCE in excess of 16%, with the fourth quarter well above both Q3 and our medium-term target range of 14%-16%. To sum up, on slide 18, we delivered a strong quarter amid a dynamic environment, and we are optimistic about the outlook for the fourth quarter and into 2023. We expect to continue to see significant benefits in our net interest income from the higher rate environment.
Our diverse fee business is driving solid results, and our capital markets business, in particular, is well positioned for when markets stabilize. Our commitment to operating efficiency remains a hallmark. We are well prepared for a slowdown in the environment with a strong capital, liquidity, and funding position, and we are being prudent with respect to our credit risk appetite and loan growth. At the same time, we are playing some offense, executing well on strategic initiatives in each of our businesses that will deliver medium-term growth and outperformance. With that, I'll hand it back over to Bruce.
Okay. Thank you, John. Alan, why don't we open it up for some Q&A?
Thank you, Mr. Van Saun. We are now ready for the Q&A portion of the call. If you would like to ask a question, please press one, then zero on your telephone keypad. You'll hear an indication you've been placed into queue, and you may remove yourself from the queue by repeating the one then zero command. If you're using a speakerphone, we ask you to please pick up your handset before pressing any buttons. Again, if you have a question, press one, then zero at this time. Your first question comes from Scott Siefers with Piper Sandler. Go ahead, please.
Morning, everyone. Thanks for taking my question.
Morning.
John, if you could expand a little on your thoughts regarding NII dynamics into next year? You know, I thought the 3.50% year-end 2023 margin expectation, you know, that was definitely a highlight. I think just generally your comments about loan betas overwhelming deposit betas, you know, sort of cumulatively, those suggest some confidence that NII should continue to grow after the Fed stops tightening. Just would love to hear your thoughts on the puts and takes and the additional color you might be willing to add?
Yeah, sure. So I just break it down into two overall categories. You've got the net interest margin dynamic, which is a big driver, and we're messaging that we expect our net interest margin to continue to rise. You know, I think loan betas in the last cycle for us were, you know, up near 60% or so. This cycle, we're doing some more hedging, so you could see our loan betas dropping a little bit. The nice part about that is that it provides that downside protection. So you're going to see loan betas in the sort of low to mid-50s. You compare that to a deposit beta that we previously messaged would be around 35% or so. You know, rates have been up 100 basis points since then.
I mean, you could see our deposit betas maybe getting into the upper 30s or thereabouts, given cumulatively what's going on with rates, you know, in the recent couple of months. You take that dynamic and see cumulative loan betas exceeding deposit betas, and that drives NIMs higher. We're also remixing on the loan side into more variable. You're seeing the strength of the multiyear investments on the deposit side playing out. Let's not forget the other aspects of the balance sheet where you've got securities book. That securities book is funded, you know, primarily by DDA and some wholesale.
You can see the front book, back book dynamics really taking hold where you've got, you know, securities yields on the front book in the fourth quarter, you know, somewhere between 4.50% and 5%, you know, and with a 2% runoff. That's pretty powerful when you've got, you know, essentially a strong DDA underpinning, you know, what's going on there in the securities book. Those are some of the net interest margin dynamics. If you flip over to the other side of things where, you know, you see our opportunity for continued loan growth, you know, where you're seeing us rotate into more of a variable rate approach, solid opportunities in home equity and other aspects in the retail side.
Commercial is, you know, we're feeling optimistic on the commercial side and that's gonna drive loan growth into 2023. It'll be economic environment dependent, but nevertheless, the underpinning of rising NIMs, I think is really what gives us the confidence to continue to see that NII improving into 2023.
All right. That's perfect color. Thank you very much for that. I guess just, you know, with rates having moved so much, just curious about your thoughts on sort of the Citizens Access product. You know, what kind of trends are you observing about sort of the stickiness of those customers? How much is loyal? How much are sort of shopping for rates? And are your tactics at all changing with regards to that product?
Brendan, why don't you take that one?
Yeah, thanks. We're seeing some decent growth in Citizens Access. The digital native customer still existing out there and is waking up a little bit as rates have gone up. It's been a very effective strategy for us. The customers are loyal to Citizens. We're seeing good augmentation from those customers, a very real brand-engaged customers. The customer base is growing. Our balance growth is coming from both sides, new customer acquisition and existing customers bringing us more as we've brought rates up. Most importantly, it serves to sort of have an isolated deposit-raising strategy to protect the core bank from needing to bring in, you know, rate-sensitive customers into the bank. We're really relationship-focused in our core franchise.
The combination of the health of our deposit franchise improvement led by DDA and primacy of our customers has been really showing up well. Our deposit betas in consumer are dramatically different than they were in the last cycle. It's really for both of those points, the turnaround in the health of the customer franchise in the core bank, and then the effective strategy of using Access both to drive national growth, but also to have a much more targeted and isolated way to grow interest-bearing deposits that doesn't make us reprice our whole book. We're really pleased with how it's playing out. Citizens Access is right where we thought it would be, and it's being executed really well.
The strategic aspects of Citizens Access that over time is just a whole nother, you know, benefit of that platform.
Correct. I think that's what obviously we've messaged that on these calls before, but the integration of our Citizens Access deposit platform with all of our national lending businesses to make our national platform much more integrated and customer strategic. John mentioned the launch of our new app and our cloud-based migration. We are making really sizable progress on bringing together all of our national capabilities to deepen those relationships as well as just sort of the deposit angle that we launched with a couple of years back.
Yep. Perfect. Thank you very much.
Thanks.
Your next question comes from the line of Erika Najarian with UBS. Your line is open.
Hi. Good morning, and thank you so much for the crisp and impactful messaging from this morning.
Sure.
My first question is for you, Bruce. You know, you have teased that your Top Eight is underway. You know, as we think about how much you've improved the bank, you know, and John has certainly helped balance sheet, and Brendan and Don have helped balance sheet positioning. You know, what is your vision for what Top Eight could accomplish? You know, we're looking at a bank clearly outperforming the market today, outperforming expectations. You know, it feels like a lot of the big rates of change have been accomplished in the previous seven plans. That's sort of the genesis of the question. What do you envision Top Eight to accomplish?
Yeah. Well, you know, Erika, I think when we ended up hitting Top Two and Top Three, we were getting questions as to how much rearchitecture and reengineering of how you're running the bank is left. Are you now picking the fruit that's really high in the tree? Yeah, it was getting higher in the tree. I think what we've been able to do is exhibit this mindset of continuous improvement that we're not gonna be satisfied with how we're running the bank. We're gonna look at all aspects in terms of, you know, how we're staffed and organized and our vendor relationships and other kind of efficiency, new technology deployment to deliver more efficiencies. Over time, that's just become part of our DNA here.
We're not gonna rest and say, "Well, we just had another successful result with TOP VII. Let's take a breather." You really can't take a breather because we have investments that we wanna fund in our future, the business initiatives that we list on a couple of the slides in consumer and commercial, and that requires net investment in CapEx and OpEx.
In order to fund those things, having these top programs and finding efficiencies to self-finance those investments and keep the overall rate of expense growth modest is the equation that we've used to drive ROTCE from, you know, the 5% when we started at the IPO to 18% levels today. I think you're gonna continue to see us, you know, pursue that mindset of continuous improvement. Don't be surprised when we have a successful announcement and execution of TOP VIII that there might be even more top programs down the road after that.
Got it. Just a few cleanup questions. Thank you so much for giving us a lot of color on the ACL. You know, I'm wondering, you know, what the, you know, weighted average unemployment rate that you assume in the 141 ACL today. Just John, a quick cleanup question to Scott's line of questioning. As we think about the NII dynamics into next year, what are you assuming about deposit growth and deposit mix shift?
Yeah, I'll just take the first one is we're using some fairly conservative assumptions when we set the ACL. I would characterize it as a moderate recession rather than a short recession. The unemployment levels get up you know over 6% is kind of where we've modeled it. We think we're being fairly conservative, but we reassess that each quarter. John, I'll hand the deposit question over to you.
Yeah, sure. I mean, I think some of the trends that you'll likely see, you know, into the fourth quarter continue into 2023. I'd say the couple of items I'd highlight are starting with the customer value proposition that you're seeing us continue to invest in. It's been multi-years to build this deposit platform. In both consumer and commercial, those investments are coming to fruition and demonstrating themselves. We're continuing to invest, so you're seeing just core deposit growth coming from that. You know, you heard Brendan and us talk about CitizensPlus as an example of the core growth that we think can give us some unique ability to take some share into 2023.
Citizens Access and you know the retail CD arena is a place where we had taken that down close to zero, and so that'll come back a bit in that category. Let's not forget New York Metro. We've entered New York Metro, and we're starting to see really nice uptake that once we converted HSBC, we're gonna convert ISBC in the first quarter of 2023. So we suspect that we're gonna start to see some lift coming out of that. Then just broadly in commercial, the product and coverage investments that we've been making over the years and continue to make will offset what we're building in. You know, all of that, all of what I just described will offset you know our expectation.
We're gonna have some DDA migration as rates rise. That's built into our outlook and built into the NIM guide that we're gonna have, you know, some realistic expectations of migration. Those are some of the areas I would highlight.
Thanks so much.
Your next question will come from Matt O'Connor with Deutsche Bank. Your line is open.
Good morning. Some really good detail on credit back in the appendix, page 24 for retail and 25 on commercial. Obviously you guys have improved the mix in both areas over the last few years. Are there any signs of weakness within certain kind of customer groups that you could point to? Like what leading indicators might you suggest that we watch and that you pay attention to?
Yeah. I'll start and then maybe turn it over to my colleagues for some additional color. You know, Matt, I think what continues to be very positive is that the expectation that things will normalize back to pre-COVID levels continues to be deferred. We're only seeing very slow migration in terms of, you know, consumer charge-offs and NPAs and delinquencies. It's still kind of better than pre-pandemic period. I would highlight there that, you know, our focus on very high-quality borrowers in these portfolios, super prime and high prime, those folks are still doing pretty well through the current environment and have a lot of liquidity. We feel really good about where things sit in consumer.
Similarly in commercial, over time, we've migrated to lend to kind of bigger companies, so mid corporate space companies with in excess of $500 million in revenues. They tend to be more diversified and better credits. We also see very solid performance metrics across all the things you know, NPAs and charge-offs, et cetera. You know, on that side, you've got to go to the usual suspects if you think the economy is weakening, and that would be, you know, commercial real estate, leverage lending, and then maybe certain sectors in nonprofit, which we've heightened our monitoring in those areas. We don't see any smoke at this point. Maybe with that, let me turn it to Don for additional color on commercial.
Yeah, I think you hit it. We've actually activated our downturn playbook, which involves a lot of incremental stressing and a lot of incremental portfolio management and a lot of incremental conversations with clients. I think there's a couple pieces of good news just supporting the lack of deterioration in credit. You know, one is we think management teams going through the pandemic got incredibly focused on efficiency in their business, and they cut costs and they automated and they built liquidity and they repaired balance sheets and they hedged and they did a lot of things that were prudent from a risk standpoint. There's a little bit of a buffer, we think, in the portfolio against what could be deterioration if we go into a deep recession.
I'd say the thing we're most focused on is the real estate office portfolio given back to work. We've got fully leased office buildings and those leases are running for a couple years in the future, but we've got lease rolls that we're focused on and whether they're gonna renew or not. I think just personally, guess I was in New York City yesterday. People are back in the office. It's in New York-
Well, the other thing is a high percentage of our office property is A caliber.
Yeah. Yeah. A lot of it's suburban.
Yeah.
It's in the right places and a lot of it's in places which are in the southern tier and things like that. We don't have a lot of San Francisco, for example, where there's gonna be a lot of distress. MSAs are important in the real estate business.
Yeah.
I think the leverage book is, you know, that's, you always look at the leverage, the sponsor leverage book, you know, our strategy there, which is high levels of diversification. Our average hold is kind of $10 million-$12 million. We do a lot of leverage finance, but we distribute, you know, 95%-97% of it. We're not really seeing any kind of severe stress in the leverage book. We feel pretty good. In all the early stats, the credit loss ratios, the nonperforming loans, the watch assets, which we have very significant processes around, all seem to be in pretty good shape right now. We're not asleep. The other thing I'll mention, John touched on this, we are being incredibly disciplined on new originations.
We're really not taking on any new clients right now. We're getting very focused on returns. We're actually commanding a higher level of pricing given the current market environment. We're watching the front book very carefully also.
Yep. How about you, Brendan?
Yeah. I'd say that the health of the consumer is still very, very resilient. Having said that, we're doing a lot of the similar things that Don is mentioning, kind of putting in a proactive approach to a potential downturn. Making investments in collections, being ready for an inevitable tick in the wrong direction. We're tightening some credit on the margins. We're being incredibly disciplined on where we're lending right now, to make sure that the returns are right and we've got deep real customer relationships and it's within the risk profile that is within our risk appetite.
Having said all that, with what we're seeing kind of out the window today, the consumer is still 20% plus excess liquidity in deposits as a general statement, and charge-offs are still, you know, at 50%-60% of the rates that they were pre-COVID, and we're not seeing any meaningful signs of that reinflating. If you look at the overall U.S., the bottom decile or two of the country, you're starting to see that excess deposits burn off and they're living more paycheck to paycheck, which is where they were pre-COVID. We don't over-index on that segment. We index much higher, and so we're not seeing a lot of the pain that is potentially happening at the very bottom of the segment in the U.S. flowing through anything in our book.
Look, we're seeing some very, very early signs that potentially we're at the early days of a normalization. Credit card customers that pay in full each month, that was about 32% of our portfolio pre-COVID. It's now at 41%. It peaked at 42%. It's down a tiny bit, but it's still significantly better than what it was before COVID. We're starting to see small signs of potentially customers getting to normal, but I wouldn't say it's accelerating at all. It's still very resilient and significantly healthier than where it was pre-COVID.
Okay, great.
All right. Thank you very much for that lot of detail.
All righty.
Your next question will come from the line of Ebrahim Poonawala with Bank of America. Your line is open.
Good morning.
Morning.
I just wanted to follow up one on credit. I think, if I heard you correctly, that your ACL assumes a 6% unemployment rate. Just means I think CECL is still relatively new. I'm trying to understand, absent that unemployment rate expectations going materially higher, just if you could give us the thought process around drivers of additional reserve build over the coming quarters. Is it the CRE market? Is it home prices? Because what I'm trying to get to is unemployment's at 3.5%, 6% seems a long ways away. If that doesn't go much higher, what else would drive those reserves materially higher relative to where we ended the quarter?
Yeah, I'll go ahead and start there. I mean, I think that first I'd like to just make sure we're mindful. We've got 141 basis points against the portfolio right now. When you pro forma adjust that for Investors and some other things, you get a day one of about 130. We're 11 basis points over day one. That covers a lot. We're covering, you know, the environment that Bruce described earlier. He also mentioned a few pockets of areas that we're watching very closely. We're watching, you know, the CRE office space, and we're watching a few sectors on the C&I side.
Just reminding that we're not seeing any, when you look at where our delinquencies are, we're not seeing any early signs of any deterioration here. That could change, and that could change quickly. We're keeping a close eye on it. You know, and as things turn, you know, we'll have those areas of concern that we were focused on in the pandemic, which most of which got cleaned out and has been improved over time. Those are. That's the playbook we'll go back to. We'll go back to those areas of concern and take it from there.
Yeah. I would just add that, you know, I think we're feeling pretty good if you look at a scenario that says we get to a moderate recession and it doesn't get any worse, then the need to actually keep building may lessen from what it was this quarter. I think there was a reassessment that, you know, the Fed's gonna have to stay at higher rates, which probably increases the probability of recession a little bit, and that was reflected in going up 4 basis points.
You know, you'd have to see even greater conviction that we're likely to hit a recession or the Fed's gonna go higher with rates, which is gonna have more collateral damage for the you know, need to build on the macro outlook. Of course, the other things that contribute to higher provision is loan growth. If we have loan growth, and then I think also, as John indicated, if we have a kind of changing view on certain sector risks. We already have overlays, for example, for the things we mentioned. We have a kind of reserve built for commercial real estate office. We think that's sufficient, but our view on that could change over time. I think we're kind of sitting at a pretty good spot now.
We'll have to wait and see what happens with the macro forecasts in certain sectors and the amount of loan growth that comes through. Those things would determine whether we have to keep building the reserve and how much. I would say that, you know, I think that the concerns that we're gonna be building the way we did during the pandemic and, oh my gosh, these numbers can be kind of a runaway freight train, we don't see that at all at this point. I think those fears are overblown. It's probably one of the reasons that's cast a pall over bank stock valuations. At this point, we don't see that.
That's good color. Just one question, Bruce, on the New York strategy. Once you complete Investors integration first quarter next year, give us a sense of like, should we expect like are you adding new bankers? What are the capabilities you're adding to that franchise? Just given how huge that market can be in terms of just market share gains, not just for-
Yeah.
The next year, but for the next few years? Yeah.
Yeah. Sure. I'll start, and then maybe I'll ask Don and Brendan to talk about their businesses. You know, I think the theory has been that we bring a thoughtful approach to how we bank these markets. We really understand neighborhoods, we understand individuals, and we really tailor advice to situations to where somebody is on their life journey, kind of where they reside, et cetera. You know, on the corporate side, we also wanna be that thought leadership position where we're the trusted advisor to a company as it's negotiating its many challenges and trying to achieve growth. We've been able to stake out that ground successfully in the major cities that we compete in. We do it well in Boston.
We do it well in Philadelphia, Pittsburgh, some of our other big cities. You know, notwithstanding the fact that New York is a relatively crowded and competitive marketplace, we think that our style can be successful in New York. It's gonna take a little time. We've bought some good foundational assets. We need to bring our additional kind of culture and approach and bring our broader product set, so we can do more for customers and give them more advice and better capabilities, better customer experience. We think we'll be successful in that over time. In effect, this is a bet on ourselves.
You know, so far everything is tracking exactly the way we had expected with little signs of green shoots that we're kind of onto something pretty good. With that, let me maybe go to Brendan first and talk about the consumer and the small business side and kind of where you're making investments and sign of a view of the future.
Yeah. We're incredibly pleased with the start in New York City post the HSBC acquisition. As John mentioned, too, we've already started some integration with Investors on mortgage and wealth in New Jersey and some of the boroughs in New York. We're hiring. We're hiring up investment financial advisors, mortgage loan officers, and business bankers. We're also restacking the retail organization and infusing talent across the board. So far it's really paid dividends. The New York market and from a branch network standpoint is the most productive market out of any of our markets so far. Early days, which is an incredibly good early sign.
We're getting a lot of customers coming back to us from some of the big banks, including kind of HSBC customers that we didn't buy, but enjoyed the location and the people, and we're really starting to see some growth. Typically, when you do a branch deposit deal, you see some deposit runoff to the tune of 10%-20% in the first year. We're actually seeing the opposite. The underlying retail deposit base is actually net growing in New York right away, and we didn't have any attrition post legal day one. There's a long way for us to continue to build share, and it's early signs, but we're very bullish on what we're seeing so far. In the Investors franchise, they kind of lean to business banking more than consumer.
We're excited about that. We think the Investors capabilities and their distribution can help us accelerate our business banking strategy overall across the franchise. When we put our consumer playbook on the Investor franchise, we're seeing this big benefit already on HSBC, and they were principally a retail franchise. When we put that on the Investors franchise that didn't have a meaningful retail presence, the difference from what we bought and what we can build over time is even more substantial. We're very excited about it. There's still a lot to do. Early signs are very positive.
John?
Yeah, I would point at three things. One is the ability, as you said, Bruce, to deliver a much broader product set into the existing Investors franchise. Greatly expanded treasury services capabilities, for example, ability to hedge directly for clients, and that's well underway. We pick up a lot of very good bankers from the Investors side. Our workforce kind of quadruples overnight just with the acquisition. Second thing is we're gonna benefit on the commercial side from all the branding that Brendan is doing. The visibility in New York City of branches and advertising and the like is. The name recognition is helpful, so we don't have to explain who Citizens is to potential new clients. We are also hiring.
We announced yesterday a new market head for New York City Metro, which came from JP Morgan. We've got a new leader in place in New York, and we're off to the races.
Great.
That's great color. Thank you so much.
Sure.
Your next question will come from Gerard Cassidy with RBC. Your line is open.
Morning, Bruce. Good morning, John.
Morning, Gerard.
First kudos for a very good slide presentation. You guys gave quite a bit of detail. It's one of the best out there, so thank you. John, talking about your hedges that you put into place, slide 23 gives us a good breakout of what you have in place. Can you share with us, obviously it's protecting should rates start to go down, I would assume in late 2023 and into 2024. What kind of rate environment would work against what you just put into place or what you've had in place and you put more into place this quarter? What kind of rate outlook would this not really work that well with?
Yeah, I mean, well, let me just start off with, I think that the point of getting those hedges on in the third quarter was to allow ourselves to continue to participate in 2023 with rates rising, so that, you know, the intent of all of that was to look past this next year into 2024 and 2025 and say, you know, if in fact we end up with a lower regime in those years, you know, let's try to find ourselves into a floor that would help maintain the level of ROTCEs that we're trying to achieve. We're stabilizing revenues and stabilizing our returns by doing this. Now, of course, there's a trade-off.
That trade-off is if rates, instead of beginning to come down in 2024, if they were to remain high or go even higher, that would be an opportunity cost. But nevertheless, on an absolute basis, we've got very attractive returns being locked in through this strategy. I think that's really what we're trying to achieve.
That's, you know, Gerard, it's tricky. You're trying to find a sweet spot, and you're looking at the forward curve and talking to economists, looking at economic forecasts, and leaving yourself enough upside participation for high rates, but then also recognizing that they're not gonna stay up forever and trying to floor out your downside. You know, time will tell. You know, hindsight's always 20/20. If you went too early or you missed the window, if you had held off another six months could you have gotten better levels. Right now we feel we've done a pretty good job of, as you can see from the results today, we're still asset sensitive.
We're still benefiting as rates go up, and now we can sleep at night that we're not gonna see ROTCE slide down the pole if rates turn around and go back down.
Very good. Is it safe to assume all the counterparties are the major global investment banks in these, hedges?
Yes. Exactly.
Yeah. Okay.
First spot on that front. Yeah.
Yep. Okay. Thank you. Just the second follow-up question. Obviously you're not an advanced approach bank, and therefore the AOCI is not an issue with your CET1 ratio, which is the binding constraint for most banks or all banks. When do you think people start to get a little concerned about the tangible common equity ratio? Yours is still very healthy, but I know it's an accounting issue. We all get that. Do you think there will be a concern if it gets too low, and do you have any idea what that rate might be?
Then second, John, when you accrete the AOCI back into capital as the bonds pay off, do you know about how much will start coming in starting maybe next year in terms of the AOCI coming back into capital?
Yeah. Well, maybe I'll just start to say that, you know, we did put the TCE to TA ratio into our presentation deck today, because, you know, we do think it's worth keeping an eye on that. You know, some folks in the peer group have either bigger securities portfolio or didn't put as much in the HTM and the TCE to TA ratio is sliding quite a bit. Ours is sliding a little bit, but still appears pretty healthy. You could argue that if that's not a regulatory ratio, it's not really something to worry about significantly because it will turn around over time.
It's just effectively you've got these securities that are gonna be earning you less than if you were able to take the cash and reinvest in at today's levels. Anyway, I think, you know, we feel good. We're above 6%. In historical times that's kind of been a marker. I think we can sustain it there. We have about 30% of the overall portfolio in held to maturity, and we'll have to see where rates go. If they go up a little bit from here, we're gonna continue to generate capital. We think we can keep it at pretty healthy levels. John, I'll turn it over for you for kind of the turnaround and the rest of the answer.
Yes, great. Just to supplement the earlier one, I mean, we've got our held to maturity is around 30% right now and sort of balances that a little bit from to that point as well. As it relates to the how the AOCI will come back in, if rates kind of don't move around on us, just the way to think about it, at September 30, we have about $4.5 billion after tax sitting in that number, and that'll come in over about five years. That gives you an ability to work through that, hopefully, Gerard.
Great. No, that's very helpful. Thank you, guys.
Sure.
Your next question comes from the line of Betsy Graseck with Morgan Stanley. Your line is open.
Hi. Good morning. This is Brian Wilczynski on for Betsy. I was wondering if you could talk a little bit about the expectation to resume buybacks in 4Q and just some of the puts and takes there. You were just talking about capital a moment ago. Obviously, your reg capital position is quite strong today. But at the same time, the macro backdrop is still a bit challenging. I was just wondering what makes you comfortable at resuming buybacks at this stage. Thanks.
Sure. You know, we are kind of at the north end of our 9.5%-10% range, and we indicated we would expect to land there at the end of the year. I think if you look at our target range relative to peers, we've been a little on the conservative side, which I think has served us well, and particularly going into an environment with a significant amount of uncertainty, that's the position we wanna be in. Having said that, you can see the level of profitability we have now is very significant, so we're generating a huge amount of tangible equity each quarter, this quarter, next quarter.
We could certainly blow past 10% if we weren't back in the market buying our stock. I think there's opportunity for us to even improve that ratio a little further and be in the market buying our stock. The wildcard often is, you know, the amount of balance sheet growth and are there any acquisitions likely in the near term. I think on that score, we've given you the guidance for what we see for loan growth, so that's factored in. You know, I'd say on the acquisitions, we've really only done very small acquisitions so far this year. We've really been 100% focused on making sure we're integrating the ones we did last year.
We had a pretty banner year last year with the New York Metro play and then JMP and DH Capital. We focused on integrating. We feel really good about where those are. Nothing big likely before the end of the year, even just in terms of the fee-based deals that we do. I think we have the wherewithal to go out and build the ratio a bit further, plus get in the market and buy back some stock.
Okay. Thanks.
Your next question will come from Ken Usdin with Jefferies. Your line is open.
Hey, thanks. I know we're getting over an hour here, so just a quick one. Follow-up on Gerard's question. How through the hedging program do you feel like you are at this point, given what you show us on that great slide 23, have you kinda done what you need to do? If not, you know, how much more might you think you need to, you know, still add to get that asset sensitivity to the position you really want it to live in? Thanks.
Yeah. I mean, I think, you know, there are many things we consider when we work through this. We think about the evolution of the balance sheet, where we think rates are going to go, et cetera. But if you look at our 3.3%, most of that's on the short end. If you were to say, "Okay, we know that the Fed's not going to raise rates anymore," and you wanted to take that down to neutral, that would mean about $10 billion or $15 billion of additional hedging that would be necessary. You know, but we're gonna be, you know, careful and methodical about that and update our balance sheet outlook, update our asset sensitivity.
You know, there's still a significant amount of hedging left to do, you know, before we would say that we're done with this cycle.
Yeah.
Just a quick follow. John, that point you made in the deck about 4Q 2024 NIM floor of 3.25% and a down 200. If the Fed does hang high, do you have an idea of what that NIM looks like in a down 100 scenario?
Yeah. I mean, it's somewhere between the two, right? I mean, I think it's
Okay.
Somewhere between the two. I mean, I'd say that would be a better outcome for us, and you could expect that that'll be somewhere between the two, the 3.25% and 3.50% bookends that we gave.
Okay. That's fair. All right. Just wanted to make sure it was pretty symmetric. Thank you.
Yeah.
Your next question will come from the line of John Pancari with Evercore. Your line is open.
Morning.
Hey.
Hi.
On the capital markets side of the business, I know you indicated you expect a seasonal increase in the fourth quarter. I mean, if you could help us size that up or how you think about the magnitude there, based upon your pipeline?
Yeah.
John, we had a little trouble hearing you.
Yeah. I mean, I think I got it. Yeah. John, we've got pipelines bigger than we've ever had on our capital markets side. I think it's important to kind of realize that the place we play.
Is middle market and capital markets. The most troubled spots to generate revenue in capital markets is these very large M&A deals which require very large financings, and those are what are struggling with the market. We were really pleased that we were able to hold cap markets kind of flat quarter-over-quarter given all the volatility in the market. We think most of the action's gonna come in M&A. We've got a very big M&A pipeline, a lot of which does not require financing, and it looks like it's moving along quite nicely. It's not gonna double, but we think it could go up, you know, $10-$20 million in the fourth quarter. We just have to see as we go through the quarter how much volatility and what the backdrop is.
We're assuming pretty big discounts to the pipeline in terms of what we're forecasting right now. We're pretty comfortable that we're gonna have a good quarter. We do think we'll do a little better now that the currency and interest rate volatility has calmed down a little bit. That hurt us in the third quarter, because people weren't really willing to step into the market and hedge. We think we'll do a little bit better on the markets business also in the fourth quarter.
Yeah. I would just add, so we don't get carried away with Don's sanguine outlook on commercial fees in Q4. You know, when we look at our total fees at the top of the house, we'll probably still see a little leakage on mortgage production. The good news here is that servicing has held up very strong, and so our diversification has paid and can lend stability to mortgage. But there's probably a slight additional step to take in Q4. We did make some changes in our policies regarding overdrafts, where we've you know done away with NSF fees. That would clip the service charges line a little bit.
you know, you'd probably see some strength in commercial, also a bit, with a little fall in the consumer side. Overall, we're guiding to the net of that should still be stable to up modestly. We'll just have to see how much of the capital markets pipeline, as Don said, actually gets printed.
Got it. Okay, thanks. Hopefully you can hear me a little bit better. One last question. Have you sized up the size of the shared national credit portfolio? And then also what percentage of that portfolio are you in the lead position?
Yeah. I think the Shared National Credit portfolio is a pretty decent size as we've moved upmarket. You know, I'd point out a couple things. There is that kind of when you're in shared national credits in general, those are bigger companies that have multi-bank facilities and they tend to be better credits. The second thing is that we continue to migrate towards trying to aim for the lead-left position in those shared national credits, and/or be one of the book runners or admin agents, so become a meaningful bank to those overall customers. That's just been part of our strategy, and we're making good traction on that strategy.
I think, you know, a lot of times investors will think that, you know, that Shared National Credits is a particular point of risk. Our view is that actually, that's just part of the strategy, and those are actually good credits. If you get to be in the driver's seat of leading the deals, then that's the place you wanna be.
I think that's right. It's all about return against asset against deployment. Underlying the BSO strategy on the commercial side that we've talked about for quarters, we're exiting $1 billion-$2 billion a quarter of under returning assets. A lot of those are shared national credits which just haven't panned out once we've been a relationship for a couple of years. That portfolio churns quite aggressively also. Our ability to monetize through the product capabilities that we've built over the last five years is significantly different than it was five years ago. We just have many, many more opportunities to engage and become that lead bank with those clients.
That helps a lot. All right. Thanks for taking my questions.
Okay, sure. I think that's the end of the queue on the questions. Really appreciate everybody's interest and support. Have a great day.