Citizens Financial Group, Inc. (NYSE:CFG) Q4 2022 Earnings Conference Call January 17, 2023 9:00 AM ET
Company Participants
Kristin Silberberg – Executive Vice President, Investor Relations
Bruce Van Saun – Chairman & Chief Executive Officer
John Woods – Chief Financial Officer
Don McCree – Head, Commercial Banking
Brendan Coughlin – Head, Consumer Banking
Conference Call Participants
Scott Siefers – Piper Sandler
Peter Winter – D.A. Davidson & Co.
Kenneth Usdin – Jefferies
John Pancari – Evercore ISI
Manan Gosalia – Morgan Stanley
Vivek Juneja – JPMorgan
Operator
Good morning, everyone, and welcome to the Citizens Financial Group Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Keeley, and I’ll be your operator today. [Operator Instructions] 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.
Kristin Silberberg
Thank you, Keeley. 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 fourth quarter and full year 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 fourth quarter and full year 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 2 of the presentation. We are also referencing non-GAAP financial measures. So it’s important to review our GAAP results on Page 3 of the presentation and the reconciliations in the appendix.
With that, I will hand over to you, Bruce.
Bruce Van Saun
Okay. Thanks, Kristin. And good morning, everyone. Thanks for joining our call today. We’re pleased with the financial performance we delivered for the fourth quarter and the full year and we feel well positioned to navigate through an uncertain environment in 2023. We are playing strong defense with a robust balance sheet position and highly prudent credit risk appetite. At the same time, we continue to play disciplined offense with continuing investments in our growth initiatives. We are focused on building out a prudent, sustainable growth trajectory over the medium-term.
I’ll comment briefly on the financial headlines and let John take you through the details. For the quarter, our underlying EPS was $1.32, our return on tangible common equity was 19.4% and the efficiency ratio was 54%. Sequential operating leverage was 1% and sequential PPNR growth was 2.6%. Leading our performance was 2% sequential NII growth, reflecting NIM expansion of 5 basis points to 3.3% and relatively stable loans given the impact of a $900 million reduction in our auto portfolio. Growth was 1% ex this impact. Deposits were solid with 1% sequential growth, and our LDR remained stable at 87%.
Our fee businesses showed resilience and diversity given a challenging environment, down about 1% sequentially. A number of M&A fees pushed into Q1 and mortgage results were softer than expected. We maintained stable expenses in the quarter, and credit metrics remain good. We boosted our allowance for credit losses to 1.43% of loans, which compares with pro forma day 1 CECL levels of 1.30%.
We restarted our share repurchase activity in Q4, buying $150 million of stock and we ended the year with a CET1 ratio of 10% at the top of our targeted range.
For full year 2022, we delivered underlying EPS of $4.84 and ROTCE of 16.4% as we captured the benefit of rising rates and our strengthened deposit base. The results handily exceeded our beginning of year guide, which we included in the appendix of the presentation.
With respect to our guidance for 2023, we assume a slowdown in economic growth to 1% for the year, two early Fed rate hikes and a Q4 cut and inflation getting below 3% by Q4. We project moderate loan growth, partially offset by continued run off in our auto book of close to $3 billion.
Overall, we see solid NII growth as NIM gradually rises to 3.4% over the year, a roughly 8% growth in fees to kind of rebound in capital markets fees over the course of the year, solid expense discipline with core expense growth ex acquisition and FDIC impacts of 3.5% to 4%.
We announced today our TOP 8 program, which targets $100 million in run rate benefits and about 80% of that is expense impact. Credit should be manageable with net charge-offs in the 30 to 35 basis point range and we expect to build our ACL to 1.45% to 1.5% of loans. We expect to repurchase a meaningful amount of stock given strong profitability, modest loan growth and limited expectation for acquisitions with our CET1 ratio forecast near the high end of our 9.5% to 10% range.
Capital return to shareholders should approach 100% and yield to investors of our dividends plus capital return via repurchase put TOP 12%. So all in all, a very strong year of execution and delivery for all stakeholders by Citizens in 2022, and we feel we are well positioned in 2023 to continue our journey towards becoming a top-performing bank. We continue to make good progress in executing on our strategic initiatives across consumer, commercial and the enterprise. We’ve transformed our deposit base and are reaping the benefits.
We’ve adjusted our interest hedging to protect against lower rates through 2025. Given the improvement in our ROTCE over time, we are raising our medium-term target to 16% to 18% from 14% to 16%. We’ve stayed focused on positive operating leverage. We’ve captured the benefit of moving to a more normal rate environment, and we still have plenty of upside in our fee businesses as market conditions improve. Exciting times for Citizens.
I’d like to end my remarks by thanking our colleagues for rising to the occasion and delivering a great effort in 2022. We know we can count on you again in the new year. And with that, I’ll turn it over to John.
John Woods
Thanks, Bruce, and good morning, everyone. Big picture, 2022 was a strong year for Citizens with significant delivery of strategic initiatives against the backdrop of uncertainty and volatility in the macro environment. Most notably, we closed our acquisitions of HSBC and ISBC. We captured the benefit of higher rates with strong NII and NIM, and our balance sheet and interest rate position were well managed.
While fee revenues were impacted by the environment, we are very well positioned across our businesses to capitalize on the upside potential when markets normalize, particularly in capital markets. Mortgage margins and volumes should recover over time, and we are excited for the growth prospects arising from our wealth investments. We are actively managing our loan portfolio, focusing on allocating capital where we can drive deeper relationship business into 2023 and beyond.
We continue to maintain good expense discipline, delivering in excess of $115 million of pre-tax run rate benefit through TOP 7, generating 4.7% underlying positive operating leverage for the year and 16.4% full year ROTCE.
Let me give you the headlines for the financial results, referencing Slide 5. For the fourth quarter, we reported underlying net income of $685 million and EPS of $1.32. Our underlying ROTCE for the quarter was 19.4%. Net interest income was up 2% linked quarter with 5 basis points of margin expansion to 3.3% and relatively stable loans given a planned reduction in our auto portfolio.
Period ended average loans are broadly stable linked quarter, up 1%, excluding auto runoff. We grew deposits up 1% linked quarter and our LDR was stable at 87%. Fees showed some resilience in a challenging environment, down 1% linked quarter. We saw a modest improvement in capital markets fees driven by underwriting and M&A, but this was more than offset by a drop in mortgage fees and a CDA DDA impact in our FX and IRP business.
Expenses were broadly stable linked quarter. Overall, we delivered underlying positive operating leverage of 1% linked quarter, and our underlying efficiency ratio improved to 54.4%. Our credit metrics were good, with NCOs of 22 basis points, up 3 basis points linked quarter.
We recorded a provision for credit losses of $132 million and a reserve build of $44 million this quarter. Our ACL ratio stands at 1.43%, up from 1.41% at the end of the third quarter and approximately 13 basis points above our pro forma day 1 CECL adoption coverage ratio. Our tangible book value per share is up 5% linked quarter.
Next, I’ll provide further details related to the fourth quarter results. On Slide 6, net interest income was up 2% given higher net interest margin. The net interest margin of 3.3% was up 5 basis points. As you can see on the NIM walk on the bottom left-hand side of the slide, a healthy increase in asset yields continues to outpace funding costs, reflecting the asset sensitivity of our balance sheet. With Fed funds increasing 425 basis points since the end of 2021, our cumulative interest-bearing deposit beta has been well controlled at 29% through the end of the fourth quarter.
Moving on to Slide 7. We posted solid fee results despite headwinds from continued market volatility and higher rates. These were fairly stable, down 1% linked quarter with lower mortgage and FX and derivatives fees, partly offset by an improvement in capital markets fees.
Focusing on capital markets. Market volatility continued through the quarter. However, underwriting and M&A advisory fees picked up. We continue to see good strength in our M&A pipeline, including several deals that were pushed into Q1. Mortgage fees were softer as the higher rate environment continued to weigh on production volumes. We have seen pressure on volumes moderating and size of the industry reducing capacity, which should benefit margins over time. Servicing operating fees were stable. Card and wealth fees posted solid results for the quarter.
On Slide 8, expenses were well controlled, broadly stable linked quarter. Our TOP 7 efficiency program delivered over $115 million of pre-tax run rate benefits by the end of the year. We are excited to announce the launch of our new TOP 8 program, and I’ll cover that in a few slides.
On Slide 9, average and period-end loans were broadly stable linked quarter but up 1% ex auto runoff with 1% growth in commercial, reflecting demand in asset-backed financing and growth in CRE, primarily reflecting line draws and slower paydowns. We have seen commercial utilization moderate a bit over the quarter as inflation and supply chain pressures continue easing and clients are adjusting inventories to reflect this as well as lower CapEx in anticipation of a softer economy.
Average retail loans are down slightly, but up 1% ex planned runoff in auto, given growth in mortgage and home equity, which bring an opportunity for deeper relationships and better risk-adjusted returns.
On Slide 10, average deposits were up $1.4 billion or 1% linked quarter, with growth primarily coming from term deposits, money market accounts and Citizens Access Savings. Overall, commercial banking deposits were up 2.4% and consumer banking deposits were broadly stable. We feel good about how we are optimizing deposit costs in this rate environment. Our interest-bearing deposit costs were up 67 basis points, which translates to a 29% cumulative beta, broadly consistent with our expectations.
We began the rate cycle with a strong liquidity and funding profile including significant improvements through our deposit mix and capabilities. We achieved overall deposit growth this quarter, and we will continue to optimize our deposit base and to invest in our capabilities to attract durable customer deposits. Overall liquidity remains strong as we reduced our FHLB advances by $1.3 billion and increased our cash position at quarter end. Our period-end LDR improved slightly to 86.7%.
Moving on to Slide 11. We saw a good credit results again this quarter across the retail and commercial portfolios. Net charge-offs were 22 basis points, up 3 basis points linked quarter, which is still low relative to historical levels. Nonperforming loans are 60 basis points of total loans, up 5 basis points from the third quarter, given an increase in commercial, largely in CRE.
Retail delinquencies continue to remain favorable to historical levels but we continue to closely monitor leading indicators to gauge how the consumers vary. Although personal disposable income remains strong, debt service as a percentage of disposable income has essentially returned to pre-pandemic levels while consumer confidence has stabilized as inflation has eased.
Turning to Slide 12, I’ll walk through the drivers of the allowance this quarter. While our current credit metrics are good, we increased our allowance by $44 million to take into account the growing risk of an economic slowdown. Our overall coverage ratio stands at 1.43%, which is a modest increase from the third quarter. The current reserve level contemplates a moderate recession and incorporates expectations of lower asset prices and the risk of added stress on certain portfolios, including those subject to higher risk from inflation, supply chain issues, higher interest rates and return to office trends. Given these pressures, we are watching our loan portfolio very carefully for early signs of stress, in particular, CRE office. Back on Slide 32 in the appendix, we have provided some additional information about the CRE portfolio.
Our total CRE allowance coverage of 1.86% includes elevated coverage for the office portfolio while the multifamily portfolio has a much lower reserve requirement. The $6.3 billion office portfolio includes $2.2 billion of credit tenant and life sciences properties, which are not as exposed to adverse back-to-office trends. The remaining $4 billion relates to the general office segment for which we are holding a roughly 5% allowance coverage. About 95% of the general office portfolio is income producing and about 70% is located in suburban areas.
Moving to Slide 13. We maintained excellent balance sheet strength. Our CET1 ratio increased to 10%, which is at the top end of our range. Tangible book value per share was up 5% in the quarter, and the tangible common equity ratio improved to 6.3%. We returned a total of $350 million to shareholders through share repurchases and dividends. Our strong capital position, combined with our earnings outlook, puts us in a position to continue to return capital to shareholders through additional share repurchases.
Shifting gears a bit. Starting on Slide 14, we’ll cover some of the unique opportunities we have to drive outperformance over the next few years. We have tried to be very disciplined in prioritizing the areas that we think have big potential and where we have a right to win. So in Consumer, we’ve got four big opportunities. First is our push into New York Metro. We are investing in brand marketing, doing well in the technology conversions and putting our best people against the market opportunity.
We are encouraged by our early success with some recent client wins in commercial and the HSBC branches driving some of the highest customer acquisition and sales rates in our network. The full ISBC conversion is just around the corner on President’s weekend, and we look forward to making further strides as we leverage the full power of our product line-up and customer-focused retail and small business model across the New York market. You will see more details on Slide 28 and 29 in the appendix.
Importantly, we achieved about 70% in run rate of our planned $130 million of investors’ net expense synergies as of the end of the year and we expect to capture the rest by the middle of the year. We also continue to expect that the integration costs will come in below our initial estimates.
Moving to wealth. We’ve launched a number of exciting initiatives with Citizens Private Client and CitizensPlus as we orient the business towards financial planning led advice. These should really help us penetrate the opportunity with our existing customer base.
On Slide 15, our national expansion is another area where we have a great opportunity to build on our digital platform that has been focused on deposits for the last few years. We’ve moved that to a cloud-based platform, and we are adding our other product capabilities so that we can offer a complete digital bank experience to serve customers nationwide with a focus on the young mass affluent market segment.
Where we might have only had a lending or deposit relationship before, our vision is to build a national platform that allows us to serve our customers in a comprehensive way. And we have also been very innovative in creating distinctive ways to serve customers. Citizens Pay, for example, is an area where we have significant running room. We’ve attracted many new partners, up about 150 versus a year ago, which should really ramp the business. And we built an industry-leading home equity business, powered by our innovative fast line process, which is enabled by advanced analytics and digital innovations that have drastically reduced originations time.
Moving to the Commercial Bank on Slide 16 and 17. We filled in all the product gaps. Acquisitions brought us M&A and other advisory capabilities, and we built out debt capital market capabilities organically. We’ve hired some great coverage bankers and we are focused on high-growth regions around the country and the right industry verticals to serve larger companies. We also have a very strong sponsor coverage and are well positioned to support private equity capital. Bottom line, we have aligned ourselves with the attractive opportunities with a full product set to drive significant market share and fee revenues.
Moving to Slide 18. We are excited to announce the launch of our latest TOP program. Even as we push forward on offense with our strategic initiatives and acquisitions, it is important to remember that a key to Citizens success since our IPO has been our continuous effort to find new revenue pools and realize efficiencies and then reinvest those benefits back into our businesses so we can serve customers better. We’ve effectively executed our TOP 7 program achieving a pre-tax run rate benefit of approximately $115 million at the end of 2022. And we’ve launched TOP 8 with a goal of an exit run rate of about $100 million of pre-tax benefits by the end of 2023, with that split about 80-20 between efficiency and revenue-oriented initiatives.
Moving to Slide 19. I’ll walk through the outlook for the full year, which contemplates an economic slowdown and the end of December forward curve view of two 25 basis point Fed hikes before an expected 25 basis point cut in the fourth quarter. We expect solid NII growth, up 11% to 14%, and we project our NIM to gradually rise towards approximately 3.4% for the fourth quarter of 2023.
Our overall hedge position is expected to provide a NIM floor of about 3.2% through the fourth quarter of 2024 and a gradual 200 basis point decline across the curve, commencing in Q4 2023. In the fourth quarter, we took actions to transition $3 billion of active swaps from 2023 to forward-starting positions in 2024. And we’ve done even more so far in January to rebalance the distribution of down rate protection. You’ll find a summary of our hedge position in the appendix on Slide 30.
We expect moderate loan growth with average loans up 4% to 5%. We are targeting about $3 billion of spot auto runoff as we shift the portfolio towards products with more attractive risk-adjusted returns. We expect total average earning assets to be up 3% to 4%. On the deposit side, we see 3% average deposit growth and a 2% to 3% spot deposit decline with cumulative deposit betas at year-end reaching the high 30s. These are expected to be up 7% to 9% with a capital markets rebound building over the course of the year.
Noninterest expense is expected to be up roughly 7% or about 3.5% to 4% if you adjust for the full year effect of the HSBC and investors acquisitions and the FDIC premium increase. If the year unfolds as we expect, we should be able to drive about 400 basis points to 500 basis points of positive operating leverage.
Given current macro trends and portfolio originations, we expect that our ACL ratio will rise to the 1.45% to 1.5% level, depending upon how the economy fares. We expect our CET1 ratio to land at the upper end of our target range of 9.5% to 10%, even with our target payout ratio approaching 100%. All of this translates into a ROTCE in the high teens for 2023.
On Slide 20, we provide the guide for Q1. Note that Q1 is seasonally weak for us with the day count impact and seasonality impacting revenues and taxes on compensation payouts impacting expenses.
Moving to Slide 21. As Bruce mentioned, we have completely transformed the franchise since the IPO, executing well against our priorities and achieving our desired performance targets, and we are ready to raise the bar, lifting our ROTCE target of 16% to 18%. The key to the further ROTCE improvement is continuing to deliver positive operating leverage. As we look out over the medium term, we should see a recovery in loan and deposit growth and we will continue to be balance — continue our balance sheet optimization efforts to focus on deep relationship lending to maximize risk-adjusted returns. We are well positioned to grow fees meaningfully. And even if rates come down a bit, we expect NII to benefit from the protection we have put on through the swap portfolio.
You should expect us to stay disciplined on expenses. Credit is projected to be stable as the economy strengthens. And we continue to focus on returning a meaningful amount of capital to our shareholders through our repurchase program and targeting a dividend payout of 35% to 40%. Over this timeframe, we would expect our CET1 ratio to remain within our target range of 9.5% to 10%.
To sum up, Slide 22, we delivered a strong quarter against the backdrop of a dynamic environment, and we have a positive outlook for 2023. We are ready for the uncertainty of an economic slowdown in 2023 with a strong capital, liquidity and funding position. We’ve taken actions to protect our NIM and we are being prudent with respect to our credit risk appetite and loan growth. At the same time, we are moving forward executing against our strategy and making important investments in our business that we believe will deliver sustainable growth and outperformance over the medium term.
With that, I’ll hand it back over to Bruce.
Bruce Van Saun
Okay. Thank you, John. And operator, why don’t we open it up for Q&A?
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Scott Siefers of Piper Sandler.
Scott Siefers
It sounds like you guys rebalanced some of the hedges in the fourth quarter and are continuing to do so year-to-date so far. I was hoping you might please just expand upon how you’re thinking on how those changed since last quarter and sort of how you intend to position yourself?
John Woods
Yes, I’ll go ahead and start off. I mean on the big picture, we — asset sensitivity last quarter was around 3%. We’re a little bit below that this quarter just given the way the outlook for the balance sheet appears to be playing out in 2023. So as we’re — as you’ve seen over time, we’ve taken our asset sensitivity down. We are — most of that asset sensitivity is really driven by the short end of the curve, which we expect to remain elevated throughout 2023.
And as a result, we’re looking at some of the down rate protection that we had in place in 2023 and just repositioning that out of spot-starting active swaps into forward-starting swaps into 2024 and beyond. So we’re looking to looking to basically push that out and basically get that down rate protection smoothed out into the ’24 and ’25 periods rather than holding on to all of that down rate protection here in ’23. That’s the main objective in what we were doing in the fourth quarter, and we’ve done a little bit more of that in early 1Q.
And then more broadly, we’re looking at net interest margin, that corridor, if you will, we’re trying to protect that corridor with — at the low end, if rates were to fall by 200 basis points out in 2024, that you’ll see a floor of around 320. So you see that 320 to 340 corridor being something that over time is more narrow than you would have seen from us maybe in past cycles. So that’s the main objective.
Bruce Van Saun
And I would just add to that, Scott, in our view in the macro is that the Fed likely moves maybe most or twice the forward curve as they’ll move up 25 basis points a couple of times and then stop. And then typically, they would pause for six or seven months before they would cut. And so if there’s a cut happening, it likely happens very late in the year and maybe it could be early next year. So guided by that view, that’s kind of why we’re pushing out that downside protection a bit.
Scott Siefers
Terrific. And then just a separate question. It looks like fees will need to rebound fairly meaningfully following the first quarter to hit the guide? I know, Bruce, you had mentioned an expectation for improved capital markets through the year. Maybe just a thought or two on how you see the main drivers of that fee guide as the year progresses, please?
Bruce Van Saun
Sure. So I think really, you put your finger on it there, Scott, is the capital markets business. We’ve had really strong pipelines this year. But because of the volatility because of the fact that the Fed is still moving higher, that’s created uncertainty and just an inability to actually get the money to work from private equity or some of the deals done because the financing hasn’t been there the way it’s been in the past. And so I think as you — going back to that macro forecast as the Fed is likely nearing kind of the destination in terms of peak rates. I think that starts to loosen up the markets, the financing markets, you’ll see less volatility and a lot of the business is kind of clocked into our pipeline will start to print and get delivered, and we’ll start to see more transactions. So just by reference, most of the quarters this year, our capital markets revenues were at $90 million to $100 million. If you go back to the fourth quarter of 2021, we had $184 million of fees, so roughly double that level. So we thought coming into this year that we’d have much stronger levels of revenue generation. But the good news is we still have a great overall focus on the right sectors in the market. We’ve got a great team. And so I think you’ll see that start to rev up as we see the market conditions improve.
Beyond that, I’m also quite optimistic. We’ve made a lot of investments in the wealth business. And again, there, if you start to see some stability in the asset markets, we should get a kind of tailwind from that plus the investments that we’ve made. So feel confident about that. And then I’d say mortgage is so washed out. I keep thinking it can’t go any lower, and it did in the fourth quarter. But I think you’re starting to see people exit the business and coming out of the business. And so you’ll start to see margins expand, and I think volumes will tick-up as we go through the year, again, linked back to the Fed reaching the destination and some stability on rates. So those would be the big things. I’m happy to pass the horn here. Don, do you want to say anything else…?
Don McCree
Yes. I think you’ve pretty much covered it on cap markets. I said this last quarter, I’ll just remind people, again, we are a middle market investment bank. So we’re not dependent on these giant transactions that need $5 billion of financing. We do singles and doubles all day long, and our pipelines are reasonably strong with a very heavy content of private equity who is a watch with cash. So there will be transactions. If you don’t get regular way transactions, you’re going to get a lot of restructuring transactions. So there’s minority capital. There’s a lot of different ways to skin the cat. So we’re relatively optimistic about what’s ahead of us in the coming year.
Bruce Van Saun
Yes. Brandon, anything…?
Brendan Coughlin
I think you nailed that pretty well. I’d say well for the year, we’re projecting slow and steady, continued progress, and it’s a bit of a hopeful coiled spring when the equity markets really come back. But as long as they’re stable, we should see some growth. I’d say the other bright spot is debt and ATM fees that continue to hit records both through customer engagement and primacy and all the investments we made in the health of the franchise that’s also translating into our deposit quality, also some restructure on vendor relations and such that’s giving us a bit of a boost there, too. So that should be a continued area of slow and steady progress.
On the other side, there will continue to be a little bit of pressure still on overdraft income and service charges, but we’re sort of near the — that’s in the run rate. Most of that’s in the run rate. So we’re sort of near the bottom, which is good that we’ll move away from being a headwind for us, real soon.
Operator
Your next question comes from the line of Peter Winter with D.A. Davidson.
Peter Winter
I wanted to ask on credit. John, you mentioned that most of the increase in nonperforming loans was commercial real estate. I was just wondering, was that office related? And if you can just give a little bit more color on what your outlook is for office?
John Woods
Yes. Maybe I’ll just talk about the coverage levels. Just broadly, as you may have seen in our materials that the CRE coverage from an allowance standpoint is around 186 basis points. But when you carve out some of the really high-quality stuff in multifamily and credit tenant lease and life sciences, you get to our general office segment, where we have very healthy coverage of around 5%. So there are some — we are seeing some trends there that are telling us that we should be putting away some reserves to deal with the back-to-office trends that are a headwind in that space. So you got good healthy coverage of around 5%. We are seeing some of that tick into the nonaccrual space. I would say more broadly, that will — even though that goes into nonaccrual, our overall pre-LTVs are typically around 60%. And so you got to distinguish from non-accruals for actual loss content. And so even though we’re putting some allowance away, we feel like that’s commensurate with the loss content that we see in the book. And I’ll just stop there and…
Bruce Van Saun
Hey, Don, do you want to add?
Don McCree
I’ll just say for the office portfolio, but CRE in general, it’s first and foremost, who’s the sponsor and who’s the investor, and we have a very high-quality group of investors that we do business with, which are largely institutional. Second is what MSAs are you in and where are you? And we think suburban will do better than urban. As we said in the comments, we’re heavily weighted to suburban. So we’re going through every single property in the office portfolio. We’ll restructure a lot of them with the sponsors. We restructured one already this year where the sponsor-contributed equity. So we’re comfortable around where we are with the coverage ratios right now, but we’ll be active in restructuring the portfolio. But we kind of like the contours of what we’ve got.
Peter Winter
Got it. And then just as a follow-up, can you just talk about what changed in the updated margin guidance of towards 3.40 versus the prior guidance of 3.50? Is it just the higher deposit beta outlook?
John Woods
Yes. I’ll go ahead and cover that. I mean I think more broadly, it’s two overall comments, really the — just given the pace and speed of rate changes and the impact on the migration of the deposit mix that we expect as you get into 2023 is really most and the majority of what we’re looking at. So — and that migration manifests itself in two ways. It’s really the amount of DDA migration that we see as well as the cost of our relatively low cost deposits that we’re seeing not only within our platform but across the industry.
So from that perspective, just kind of marking that to market with respect to what we’re seeing in the trends in the fourth quarter and the rate and curve outlook that we see going throughout the rest of ’23, I would hasten to add the — what’s embedded in there nevertheless, is a transformed deposit platform that back — prior to the pandemic, we would have had DDA percentages that would be in the low 20s compared with a majority of the portfolio being outside of DDA, of course.
But you fast forward to where we are in the fourth quarter, and we’re at 28% of our deposit franchise is sitting in DDA. That’s a significant increase versus pre-pandemic. And we expect to end the year in the sort of the mid- to high 20s in the DDA space, down a little bit from where we are today, but nevertheless, still very high quality. When you add in consumer CRE and consumer savings, which is other low cost, you end up with still about [15%] or more of our deposit portfolio sitting in low-cost categories. That’s up from the low 40s prior to the pandemic. So this has been a multi-multiyear transformation of the deposit franchise.
So I think we’re basically just calibrating what we expect in 2023, which is with the majority of what we saw in terms of the decline from 3.50 to 3.40. I think you could also add in what’s going on with the curve and front-book, back-book as well. When you look at it just how quickly rates are rising, the front book originations take a longer time to contribute. And from that perspective, we’re seeing that being a driver as well.
And then not only the speed of — I guess, the last point I’ll make is not only the speed of rates rising, but the inversion of the yield curve is something that is also pretty — is a headwind to front-book, back-book. Just to end it with nevertheless, front-book, back-book is a positive tailwind over time. We’re seeing 300 basis point of positive front-book, back-book across securities and our fixed rate lending businesses, that’s still a tailwind. And that’s going to be a driver into 2023 with net interest margins rising just not by quite as much as we thought last quarter.
Operator
Your next question comes from the line of Ken Usdin with Jefferies.
Kenneth Usdin
Wondering, Bruce heard your earlier comments about we’re at 1.30 ACL day 1 adjusted for the deals in the low 1.40s now and your comments about 1.45, 1.50 year-end. I’m just wondering if you can help us, given that you’re slowing loan growth and letting the auto book run out, how do you just help us understand what you’re seeing in terms of what your CECL impact might be looking ahead versus the impact of slower loan growth in terms of that endpoint that you’re expecting?
Bruce Van Saun
Sure. I’ll start. John, you can pick up. But I’d say what we’ve done for the past several quarters is kind of keep looking forward as to what’s the macro forecast and are there any particular segments of the portfolio that could come under stress given that the Fed has continued to push higher and the economic growth has been downgraded. So I think there’s — like I read today that over 60% of the leading economists are projecting a forecast for this year. So the reason that we’ve been building gradually is just taking that into account.
I think at some point, you kind of get the cards turned up in 2023, and you’ll have more information and less uncertainty, but we don’t see that where we sit today. So I think it’s prudent to continue to view the course — likely course, is that the ACL will go up a couple of basis points a quarter like we’ve done and get into that 1.45 to 1.50 range. At some point, then you’ll have seen whatever the recessionary impact is, and then you’ll be looking forward and then you may get to the point where you can release some of those reserves depending on what your charge-off experience is. Clearly, Ken, the slower loan growth plays into that, to some degree is mitigating what the build could have been, but anyway, those are the dynamics that like, John, I don’t know if you want to add to that?
John Woods
Yes. I’ll add that. I mean just for the last couple of quarters, we’ve had a mild-to-moderate recession built into the. And so our peak-to-trough GDP decline that we have built into our models are 1.5%. That would be a moderate recession at this point. I think the changes you may have seen in the second half of ’22 were not quite as much on the expectation that there would be a recession as much as what the collateral value outlook really impact was.
So when you think about house prices and used car prices, et cetera, we’ve been increasing the amount of decline expected. So you’ve got sort of the low to mid-teens declines now built into our models for both house prices and auto prices over the foreseeable and kind of period. And so that’s really — and that’s not really driving a lot of losses, just we’ve been having a lot of recoveries in the portfolio over the last year or so. And so you may then — you might see some lower recoveries and that will have the — you saw our loss that’s built into our loss forecast for ’23. But I think that’s an important item that you saw in 4Q in terms of our outlook for 2023 and 2024.
Kenneth Usdin
Got it. Okay. And just one quick follow-up on the capital point. You’re nearing 100% implies a nice incremental step up in the buyback. I’m just wondering how you’re thinking about the mix of the dividend versus the buyback going forward, yet you obviously moved to $0.42 in the third quarter. Should we also think about that you would be moving the dividend up in line with increased earnings potential as well within that context?
John Woods
Yes. I’d say what we do here is every year, we’re on a cadence where post-CCAR, we basically take that as the opportunity to broadly update our capital return profile. Over the medium term, we’re looking at 35% to 40% dividend payout. And you saw that in some of our medium-term outlook. We’ve updated that this is going to be more of a buyback return year in ’23 because of the outlook for RWAs. But we take a look at a dividend policy and earnings outlook and update whether there should be a change in the dividend after CCAR.
Bruce Van Saun
Yes. And I would just add to that, Ken, that clearly, with the uncertainty in the environment, we are being cautious in terms of the lending of kind of risk appetite. And so I think that, in and of itself, creates some additional capital versus what we’ve had in prior years. I also think we still have our plate full integration of existing acquisitions and we haven’t seen a whole lot that’s attractive at valuations that we’re interested in on the acquisition front.
And so I think the combination of operating at very high profitability levels with ROTCE returns in the high teens plus more modest loan growth than historical, more modest acquisition activity than historical creates the opportunity. And I think it’s appropriate given the uncertainty and chance for recession that returning capital to shareholders is the right course of action here. So you could expect we would like to raise the dividend during the course of the year, and we’d also like to get close to that 100% return of capital to shareholders.
Operator
Your next question comes from the line of John Pancari with Evercore.
John Pancari
On the overall deposit dynamics, I know you expect a 2% to 3% year-over-year spot decline. Can you maybe give us a little more color on how you expect overall deposit trends to progress through 2023 to get to that 2% to 3% spot decline? Maybe help us with the magnitude of declines that you think is reasonable here in the coming quarters as you look at deposit flows?
John Woods
Yes, sure. I’ll jump in there. I mean I think…
Bruce Van Saun
You can just start and then maybe pass it to Don and have Brendan.
John Woods
Sure. Yes. That sounds good. Yes. I mean, I think overall, as I mentioned before, we’re seeing deposit migration from a DDA perspective as well as from some of our lower cost levels. But broadly, the mix is superior and improved compared to pre-pandemic. I think we’re around 28% DDA in 4Q, that’s probably going to tick down a bit, call it to maybe 27% or so by the end of the year. That’s part of the story. I’d say the — some of the higher cost deposits in money markets and savings will be part of the runoff as well such that you get to something along the lines of 2% to 3% declined spot-to-spot end of ’22 into ’23.
And so I’d say that you end up with some, again, improved mix compared to pre-pandemics, but a little bit of mix softening as you get throughout ’23. And I’ll just…
Bruce Van Saun
I would just add — I would add to that is that I’d say we did not take in as much surge deposit as many in our peer group. We have a consumer-tilted deposit base, which tends to be more stable. And so we’ve been monitoring that surge deposits quite carefully. And we have seen it actually be more sticky than we initially expected. I think where you’d see a slight runoff probably is more on the commercial side where treasurers have other alternatives besides bank deposits to move some money out. But again, we’re relatively protected there because we didn’t take in a lot of that money in terms of search deposits. So maybe, Don, you could comment here or Brendan?
Don McCree
Yes. I think our spot is down a little less than 2% year-to-year. We actually ended this year a little higher than we thought we were going to because we had some nice inflow at the end of the year. But back to — I think John said it in comments, we’ve really transformed our deposit base really off the back of our treasury services business, so both specialty deposit offerings, we’ve got two that we’re now in the market with around ESG, green deposits and carbon offsets and then just the strengthening of our DDA deposits with our treasury services business gives us more stability than we would have had in prior years. So we feel pretty good about that projection.
And we’re — in general, we’re really managing the balance sheet from a BSO standpoint and really we’re avoiding most new transactions given just the shyness around the credit environment and the uncertainty, and we’re moving clients who aren’t generating positive returns off the franchise and off the balance sheet. So it gives us a little bit of a dynamic that we don’t really need to go chase deposits because we’re keeping the loan side relatively modestly in terms of how it grows.
Brendan Coughlin
Yes. Without being too redundant to what John mentioned, I’d say consumer has been broadly stable on deposits, which is a really good thing. And the story for us is going to be controlling the mix, but all indications are quite positive. We look at a lot of benchmarking data, and we’re pretty confident that we’re performing in the top quartile of our peer banks in terms of retention of low-cost deposits as well as interest-bearing deposit costs so far in the cycle. It’s sort of midway through the cycle.
So we’ve got to stay disciplined and manage it well, but it’s been driven by a lot of health improvements, household growth, improvements in primacy, mix shift to Bruce’s point, we were 45% mass affluent and above five years ago, we’re now 60% of our customer base is mass affluent and above. So the quality has been quite good.
On the stimulus front, what we’re seeing is the bottom two deciles of our customer base is essentially at the paycheck to paycheck. So that stimulus has already burned off and is in the rearview mirror. So the stimulus that remains with us tends to be with the more affluent customers, whether that’s actual stimulus check. So that’s balance parking that happened during COVID for not making mortgage payments and not traveling, et cetera, et cetera. We’re not actually seeing that burn off as much as we’re starting to see that rotate out of low-cost deposits into interest-bearing, which is natural given the stated interest rate.
So we’re managing that really tight. All the investments we’ve made in the franchise, whether analytics, new products, the introduction of CitizensPlus in our Private Client Group as well as having Citizens Access to fence off interest-bearing deposits to maintain discipline in the core have all been really big levers for us to manage well. And all indications we see so far is that we’re right on track with where we want it to be and dramatically outperforming where we were last time and up rate cycle and at worst, in line with peers, but some signs that we may be doing a bit better, which is a big turnaround from where we were five, six years ago.
John Pancari
Okay. Great. That’s helpful. And then separately on the commercial real estate front, I know you stated 60% LTV on overall commercial real estate. Is that origination? And then do you happen to have refreshed LTV? I know you mentioned that a lot of your deals have sponsor participation, but we’re hearing that with sponsors exiting or refinancing out certain deals that’s impacting the LTV, so the refreshed LTVs may be a better read, particularly on the office front.
John Woods
Yes. The office — the 60% was the office LTVs in terms of not the overall CRE book. So we think those are still pretty good. We’re refreshing the property by property. We haven’t gone through and done a total refresh on the entirety of the book yet, but we’re kind of working on the maturing quarter-by-quarter maturities and working with the sponsors to either refinance out, inject equity or adjust the value of the portfolio. And that’s what drove the NPL this quarter. It was really one real estate deal.
John Pancari
Okay. Sorry. So that 60% is a refresh number on the office side? Or is it at origination?
John Woods
It’s all throughout origination.
Operator
Your next question comes from the line of Matt O’Connor with Deutsche Bank.
Unidentified Analyst
This is [Megan Stein] on behalf of Matt O’Connor. On capital, so the 9.5% to 10% medium-term CET1 target range, that’s well above the regulatory minimum. You’ve built reserves a lot, and it seems like the conversion time line of ISBC is going really well. So I guess my question is, I hold so much capital down the road given solid reserves and successful deal integration time line?
Bruce Van Saun
Yes. I would say part of it is just the philosophy of liking to have a strong balance sheet. And so I think 9.5% to 10% is a strong ratio. You’ve seen over time that we’ve originally had a target of 10% to 10.5%, and we’ve been kind of sliding that down as we — our profitability goes up. And I think the stakeholders gain more confidence that we have a good strategy, and we’re executing well. So it wouldn’t surprise me at some point where we start to manage down in that range. I think the time of 2023 today, we’re looking at a potential recession to be at the top end of that range makes sense. But once we get to the other side of that to start to move that down and maybe manage that closer to the bottom end of that range will provide more leverage. And then at that point, I think we could step back and say, do we still need 9.5% to 10% or can we skinny that down a little bit? So I think that’s all in front of us, we thought at this point, given the dynamics around 2023, it wouldn’t make sense to actually move that target range down.
Unidentified Analyst
Okay. And just a — second question is just on loans. So the $3 billion auto runoff will offset growth in other areas this year. What are your expectations for other loan categories in 2023 coming off of a strong 2022?
John Woods
Yes. I’ll go ahead and start there and others can chime in. But I mean, I think when you look out into 2023, we still see very, very strong opportunities in the commercial space and within C&I. And I think something to always keep in mind is our utilization is well below where historical levels would imply we should be. And so as you get into the later part of the year, you see some recovery in investments, in inventories and CapEx and possibly M&A, which actually provides financing opportunities. We see lots of opportunities across commercial. And that’s really one of the main drivers.
When you get into consumer, we’re looking at home equity being a place that a place that we like and card and Citizens Pay would contribute as well. So that wraps up to a stable year-over-year loans and back to the point around that being taking that otherwise RWA that would have been deployed against auto and some other categories with lower risk-adjusted returns and giving that back to shareholders.
Operator
Your next question comes from the line of Manan Gosalia with Morgan Stanley.
Manan Gosalia
I just wanted to follow up on the NIM line of questioning. I think you brought down the floor for NIM from 3.25% to 3.2%. Is that also a function of what you mentioned on the DDA migration and the curve and also the fact that you pushed out the forward swaps. Is the biggest variable on that number, mostly the cost of funding side? Or I guess would there be any changes to that 3.2% number, the Fed cuts rates sooner?
Bruce Van Saun
Yes, I’ll start and flip to John. It’s Bruce. But I think the two numbers are tethered together. So if the 3.50% is now seen to be 3.40%, then your floor is going to also commensurately move lower. The good news is, in a way, is that we’ve tightened the bottom side of that range. So previously, it was 3.50% down to 3.20%, 3.25%. So it was 25 basis points and now it’s 3.40% to 3.20%. So it’s 20 basis points. So anyway, I think we — certainly, John’s initial answer on the movement down has been focused more on migration, the DDA and low-cost migration, but then also some of the impact from the yield curve on front book back book has been the other dynamic. So those are the things that we’re watching. But John, you can out from there.
John Woods
Yes. I’d say the only thing I’d add, just to remember, we constructed — we modeled that 3.20% and there’s a lot of assumptions that go into that with respect to what the mix of the balance sheet would be, et cetera. And what we’re assuming is a 200 basis point gradual decline in 2024 that would get you down to that 3.20%. And given that we are still asset sensitive and we haven’t closed out that position, that’s really what you’re seeing in terms of the decline in net interest margin.
So as and when we continue to look at ways to lock in protection against down rates, you could see that 3.20% move around based on hedging activities as well as updated views on what the mix of the balance sheet is likely to be in the context of what’s the Fed…
Bruce Van Saun
It’s a very dynamic process. So we look and see where the forward day rates are going to be. We have our own view of that. We see what the valuations we can get in the hedge market are. And you can be assured, I think we played our hand quite well so far, and we’ll continue to stay really focused on.
Manan Gosalia
I appreciate that. And then separately, just on the program. Can you unpack some of the drivers there of the $100 million in pre-tax benefits and maybe how quickly those can come out from the expense base over the course of the year?
John Woods
Yes, I’ll go and cover that. I’d say the one dynamic to keep in mind is that we tend to form these programs and generate a year-end run rate benefit that will contribute for each of them. Mostly on the one hand, the $100 million will build throughout ’23 so that it gets to a run rate when you get to the fourth quarter of ’23. But keep in mind, we did the same thing with TOP 7. So there’s a full year effect of TOP 7 that comes in.
And so when the programs are reasonably similarly sized, you can almost use that as an estimate of what the contribution is in any given year. And so you have maybe a combined $100 million plus contribution from the full year effect of TOP 7 hitting ’23 and the in-year effective TOP 8 hitting ’23. And so the big drivers of that really you’ve got the traditional areas that we focus on, which is third-party costs and vendor cost management, which is an area that’s been contributing over the years as well as continue to optimize the branch network. And just being really careful about ensuring that our organizational approach is fit for purpose with respect to what we’re trying to accomplish in ’23. So those are more traditional areas.
The other places we’re looking at that have been more recent include maturing our Agile delivery model away from a waterfall approach to agile and next-gen technology initiatives continue to contribute as well. We’re working towards a data center exit in 2025. We’re looking to migrate to the cloud from our internal applications, and that’s contributing in ’23 as well. But there’s a lot of very strategic sort of initiatives that are built within the TOP 8 program and we’re excited about it. It’s part of who we are, and we’re looking forward to deliver against that next year.
Operator
Our next question comes from the line of Vivek Juneja with JPMorgan.
Vivek Juneja
A couple of questions for you folks. Firstly, the deposit betas that you expect to get to the high 30s. Given the pace of change in the fourth quarter, should we and your expectation for rate hikes early in the year and not after that, should we expect you get to that in Q1? Any color on that, on the pace of it, especially given how rates have been going up?
John Woods
Yes. I mean I think we’ll not get there in Q1. That is an over-the-year expectation in terms of the cumulative growth. I mean I think you’ll see the growth in cumulative betas begin to moderate and flatten out. You have the big jumps early in the cycle. So we began and go way back to the second quarter of ’22, our cumulative beta was 6%. And then you get to the fourth quarter, the cumulative beta is 29. So you’ve got 23 points just in ’22 and you’ll have — and then we’re looking for in ’23 is another 9 points.
So this — and it will increase over time. You won’t get to 38 in the first quarter and will gradually…
Bruce Van Saun
Deposit tend to replace reprice with a lag. So even after the Fed pauses, you still see a little bit of upward pressure on those betas.
John Woods
That’s right.
Vivek Juneja
But I would — okay. But then does that mean, Bruce, the bulk of it is probably early on and just a little further increase after that, after the Fed is done?
John Woods
I’d say the majority in 1H and it continues to trickle-in in 2H, and that’s built into our outlook.
Vivek Juneja
Okay. Different question, a second one. Fee income, your guide of about 7% to 9% growth in full year ’23 versus ’22. How much of that would you expect would come from capital markets or at least what’s in your forecast that you’re thinking how much comes from capital markets?
John Woods
Yes, I think there’s a big part of it. I mean, back to the big drivers, you had capital markets, and you heard about card fees from Brendan and wealth from Brendan as well. So those are the three big ones. You see mortgage really potentially rebounding as well.
Bruce Van Saun
A little bit of rebounding.
John Woods
But a big part of it would come from capital markets from the underwriting perspective and M&A advisory, just as we may have mentioned in the fourth quarter, we saw some deals pushed from 4Q into 1Q. So that’s going to support the capital markets business, which, by the way, over the years, has really become a very diversified capital markets business itself. I mean just broadening out M&A advisory, underwriting and loan syndications. Those businesses really tend to really diversify our overall fee outlook. But yes, a good part of it and a good chunk of the growth in ’23 comes from capital markets.
Operator
There are no further questions in queue. And with that, I’ll turn it over to Mr. Van Saun for closing remarks.
Bruce Van Saun
Okay. Great. So thanks again, everyone, for dialing in today. We certainly appreciate your interest and support. Have a great day.
Operator
Thank you. That does conclude today’s conference. Thank you for your participation, and you may now disconnect.
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