Earnings Call Transcript - FCNCA Q2 2024

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the First Citizens Bancshares Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer section. As a reminder, today's conference is being recorded. I would now like to introduce the host of this conference call, Ms. Deanna Hart, Senior Vice President of Investor Relations. You may begin.

Deanna Hart, Senior Vice President of Investor Relations

Good morning. Welcome to First Citizens' second quarter earnings call. Joining me on the call today are Chairman and Chief Executive Officer, Frank Holding; and Chief Financial Officer, Craig Nix. They will provide second quarter business and financial updates, referencing our earnings call presentation, which you can find on our website. Our comments will include forward-looking statements, which are subject to risks and uncertainties that may cause actual results to differ materially from expectations. We assume no obligation to update such statements. These risks are outlined on Page 3. We will also reference non-GAAP financial measures. Reconciliations of these measures against the most directly comparable GAAP measures can be found in section 5 of the presentation. Finally, First Citizens is not responsible for and does not edit nor guarantee the accuracy of earnings transcripts provided by third parties. I'll now turn it over to Frank.

Frank Holding, Chairman and CEO

Thank you, Deanna. Good morning, everyone, and welcome to our earnings call. Starting on page six, and this is the second quarter snapshot slide. We delivered another quarter of solid financial results, including peer-leading return on assets, net interest margin, adjusted efficiency ratio, loan growth, CET 1 ratio and loan portfolio yield. Our board has approved a share repurchase plan allowing us to repurchase shares in an aggregate amount up to $3.5 billion. And Craig will speak to those details later. I’d like to point out that we were recently included in the Fortune 500 list for the first time. Continuing on to Page 7, I'll take a moment to focus on our business segment performance as well as their outlooks moving forward. Starting with the General Bank, we saw positive loan trends as growth remains particularly resilient in business and commercial loans within our branch network. We also experienced strong growth in our SBA, SVB private and wealth channels. Importantly, we have not made any significant changes in our risk appetite or client selection to chase growth as we feel our expertise and deep client relationships position us well to continue to grow prudently. Deposit growth in our branch network during the first half of the year exceeded our expectations. Looking forward, we see new production and client acquisition contributing to further balance sheet growth. We also see growth coming from deepening our relationships with existing customers, including SVB acquired customers. On the downside, we recognize that reductions in interest rates will cause margin compression. However, we are building strategies to mitigate the expected negative impact, including a focus on the mix of our deposits by targeting operating accounts, growing quality loans, and improving non-interest income from all sources. Our commercial bank segment continued to deliver strong loan growth driven by several of our specialized industry verticals, primarily in project financing for energy and data centers. CRE volume remains challenged, driven by the higher for longer interest rate environment; deal volume is expected to remain muted during the second half of the year. While portfolio stress is expected to remain above historic levels in equipment finance, we expect loss rates to decline in the second half of the year and into 2025. From a production standpoint, we expect this segment to continue to benefit. First from liquidity concerns, bringing the market rates on a greater number of transactions into our target range. And second, from a focus on originating larger, higher quality transactions. Funding for the commercial bank is aided by our nationwide online direct bank with more than 700,000 core deposit accounts. We plan to continue to use the direct bank as a lever to grow core deposits in the current environment where pricing pressure and competition remain high. Turning to SVB commercial, we achieved quarter-over-quarter loan growth driven by high-quality loans in our global fund banking or capital call lending business. The uptick in loans reflects both the increased level of investment activity driving up utilization and global fund banking's continued success in winning the fund banking business of active VC and PC investors. Encouragingly, we also witnessed a quarter-over-quarter increase in SVB commercial total client funds for the first time since the fourth quarter of 2021. SVB commercial deposits increased for the first time since the first quarter of 2022. These increases were driven by slight improvement in the macroeconomic environment and client acquisition. As we look ahead, it is too early to call an innovation economy turnaround, despite increasing deal counts and encouraging investment trends. We are encouraged that the rebound will be significant as high levels of VC dry powder remain a strong catalyst for future growth. We expect that the positive trends we saw in the second quarter could continue to result in gradual improvement in the second half of this year, but remain guarded about the absolute levels of deposit growth given the continued headwinds in the environment. Our SVB team remains the bank of choice for the innovation economy. Moving on to Page 8, our strategic priorities have not changed. Given our growth over the past few years, we have been focused on maturing our risk management framework and overall regulatory environment. We have made significant enhancements not only to meet category four large financial institution requirements, but to develop those capabilities in ways that are scalable through category three expectations. To conclude, we're continuing to see positive momentum in our businesses, while we recognize uncertainty remains in the current macroeconomic environment. We are committed to deepening customer relationships, prudently growing core deposits and loans, and allocating capital. We remain in a position of strength, and I'm excited about the opportunities ahead of us in 2024 and beyond. Craig, I'll turn it over to you.

Craig Nix, CFO

Thank you, Frank, and everyone joining us today. My comments will focus on the key takeaways found on page 10. Pages 11 through 28 offer more details on our second quarter results. I'll begin with a $3.5 billion share repurchase plan mentioned by Frank. While supporting organic growth is our primary focus, our strong earnings have created an excess capital position. Share repurchases allow us to return capital to our shareholders and manage capital levels more efficiently over time. We manage our capital ratios without the shared loss agreement benefits, and all planned capital activities are evaluated accordingly. We aim to complement organic capital use with systematic share repurchases, ultimately aiming to reduce our adjusted CET-1 ratio to around 10.5% by the end of 2025. This repurchase plan aligns with that objective. Moving ahead, we will review our capital management strategies based on balance sheet growth projections, earnings trends, and the economic and regulatory landscape. This will be included in our upcoming capital plan, set to be finalized in the first quarter of 2025. If earnings-driven capital increases continue to outstrip organic growth, we anticipate continuing share repurchases beyond this plan. Regarding second quarter results, all of our return metrics surpassed expectations, with ROE and ROA adjusted for notable items at 14.05% and 1.391%, respectively. Headline net interest income saw a slight increase in the latter part of the quarter—higher interest income was somewhat countered by reduced accretion and rising deposit costs. Although modest, this rise followed three quarters of continuous declines, during which interest expenses on deposits grew faster than interest income. In the second quarter, while interest expenses on deposits increased, the rate of growth slowed down. Anticipating potential Fed rate cuts, we have moved an additional $5 billion in cash into short-duration securities within the investment portfolio to partially mitigate our asset sensitivity profile. Headline NIM slightly contracted by 3 basis points to 3.64%. Excluding accretion, NIM edged up by one basis point to 3.36%, indicating that while deposit pressures persist, they are being stabilized and more than balanced by strong loan origination benefits. Prior to the second quarter, NIM excluding accretion had trended downward over the past three quarters. Adjusted non-interest income was a bit better than anticipated, driven by increased client investment fees aided by higher average balances in SVB commercial off-balance sheet client funds, which offset a projected decline in net rental income from rail-operated lease equipment. Rental income faced pressure from a return to normal maintenance expenses as previously outlined. Adjusted non-interest expense ended at the lower end of our guidance, rising sequentially by about 1%. Expense growth primarily stemmed from increased equipment costs related to accelerated depreciation on assets vacated after the SVB acquisition and favorable variances in previous periods from third-party reimbursements. Second quarter expenses included higher marketing costs as we intensified efforts to retain clients and boost the direct bank channel to counter expected declines in their time deposits and broker deposits. We are still executing on cost-saving measures from the acquisition and closely managing overall expenses. We are nearing the lower end of our cost savings goal and expect to complete this by year-end. Credit stability was maintained during the quarter; with net charge-offs at $132 million or 0.38%, we remained at the low end of our guidance range. Non-performing loans stayed relatively stable, and while losses rose slightly over the linked quarters, they were largely limited to the same portfolios as earlier periods, showing no new emerging problems outside those areas. Encouragingly, while we noted ongoing stress in the small-ticket leasing and investor-dependent portfolios, there was a modest improvement in our general office portfolio. While this is a positive sign amid the ongoing focus on CRE, especially in office spaces, we do not see it as a definitive shift in current stress levels within that portfolio, but rather a function of timing in resolutions. We remain well-reserved, with an allowance of 11.84% on the commercial bank office portfolio, effectively covering quarter two net charge-offs twofold. Overall, the allowance ratio dipped 6 basis points to 1.22%, largely influenced by growth in the global fund banking portfolio, which warrants a lower reserve percentage. The decrease is also attributed to reduced specific reserves on individually evaluated loans and stable credit quality trends. These influences were somewhat counterbalanced by an increase in loan volumes. Despite the allowance decrease this quarter, we are confident in our overall reserve coverage, particularly for portfolios under stress. On the balance sheet, loans grew by about $4 billion compared to the prior quarter, translating to an annualized growth rate of 11.8%. This growth was driven by a $2.1 billion increase in FCD commercial, primarily from the global fund banking capital call lending business, and was partially offset by expected declines in technology and healthcare banking due to ongoing payoffs and intensified competition. The general bank and commercial bank segments also noted loan growth of $1.5 billion and $386 million, respectively. While the wider industry faces lackluster loan growth, we continue to see broad expansion across our business segments, as Frank mentioned earlier. Shifting to the right side of the balance sheet, deposits grew at an annualized rate of 4% or $1.4 billion, reflecting strong core deposit growth in SVB commercial and the general bank. In SVB commercial, deposits increased by $1.9 million, with a $329 million rise in the general bank fueled by our ongoing focus on nurturing relationships with existing customers and bringing in new ones. These increases were partially negated by anticipated declines in broker deposits and a $145 million reduction in direct bank deposits, which saw a $1.9 billion drop in time deposits, tempered by an $1.8 billion rise in savings accounts, in response to pricing and projections for rates to decrease in the latter half of 2024. We strategically chose to let some of these roll off and will continue to grow core deposits to counterbalance this decline. On capital, our CET-1 ratio fell by 11 basis points sequentially, finishing the quarter at 13.33%. This was influenced by a continued reduction in the benefit from the shared loss agreement, which contributed roughly 85 basis points to the ratio this quarter, down 22 basis points from the first quarter. Without the shared loss agreement benefits, the CET-1 ratio increased by 11 basis points from the previous quarter, and earnings growth again outpaced organic growth. I'll conclude on page 28 with our outlook for the third quarter of 2024 and the full year. Regarding loans, we are raising our expectations due to a strong starting point at the beginning of the third quarter and solid momentum in our pipelines. We project high single-digit annualized percentage growth in the third quarter, supported across all our business segments. We believe SVB commercial will see benefits from growth in global fund banking, driven by successful client outreach. While the second quarter saw increased activity in commercial real estate funds, M&A, and debt activity, the market remains challenged and somewhat unpredictable. While we anticipate a modest increase in VC investment compared to 2023, we believe our growth will face ongoing headwinds from private equity and venture capital markets. We also expect continuous growth in our business and commercial loan portfolio within the General Bank. In the commercial bank, we expect our specialty segments to be crucial for ongoing loan growth. Additionally, we continue to expand our middle-market banking efforts and expect positive momentum from our strategic initiatives. For the full year, we project loans will end in the $143 billion to $146 billion range, constituting mid to high single-digit percentage growth year-over-year, concentrated across all three banking segments as previously outlined. We anticipate deposits to rise slightly in the $152 billion to $154 billion range in the third quarter due to growth in the general bank. We expect deposits in SVB commercial to remain relatively flat due to ongoing cash burn in a still-muted fundraising environment. We also expect growth in our branch network as we enhance our customer base through a successful execution of our organic growth and relationship banking strategy. For the entire year, we estimate deposits to be in the range of $153 billion to $155 billion, mainly driven by growth in the General Bank mentioned earlier, with SVB commercial remaining flat to witnessing moderate increases, supplemented by growth in the direct bank if necessary. We forecast the direct bank to stay flat to slightly higher through year-end as maturing time deposits are countered by money market and savings growth, aligning with our strategy of reducing higher-cost CDs. In the direct bank, we retain the option to lower rates more rapidly if the Fed cut cycle exceeds expectations, all while strengthening our insured customer deposit source. The implied forward curve suggests a 98% chance of two rate cuts in the latter half of the year. Our interest rate outlook spans one to three rate cuts, projecting the effective Fed funds rate to drop from the current 5.50% to a range of 4.75% to 5.25% by year-end. These projections account for planned purchasing activities in the back half of 2024. For the third quarter, assuming a rate cut occurs, we expect headline net interest income to remain stable compared to the second quarter. Our cost forecast for the cut in September takes into account expectations for lower accretion, slightly elevated deposit costs, and a marginally decreased loan yield, which should be balanced by higher yields on investment securities. For the full year, we anticipate headline net interest income in the range of $7.2 billion to $7.3 billion, an increase from our earlier guidance of $7.1 billion to $7.3 billion, reflecting the prolonged high-rate environment and potential rate cuts expected later in 2024. We still estimate loan accretion of just over $500 million for the year, down $200 million from 2023, as the loan discount from shorter portfolios will have been fully acknowledged. Despite recent positive trends, we do predict sustained elevated net charge-offs in the investor-dependent general office and equipment finance portfolios. We expect third quarter net charge-offs to range between 35 and 45 basis points, yet we are reducing the full-year range to 35 to 40 basis points given lower losses in the first half of the year. However, we caution that many portfolios in the commercial and SVB commercial segments involve large hold sizes, and an unexpected loss in one or two could profoundly influence this range. In commercial real estate, the ongoing impact of persistently high rates continues to affect values, notably in the general office sector, where market liquidity for refinancing remains sparse. We foresee these market dynamics will keep losses elevated within this portfolio throughout 2024. Some positive signals have emerged in the investor-dependent portfolio, and we believe market optimism and a growing consensus about valuations could aid in alleviating some pressure. Nevertheless, due to the uncertainty surrounding the innovation economy, we expect ongoing stress throughout 2024. Regarding adjusted non-interest income, we predict that the third quarter will be largely in line with, or decline slightly from, the prior quarter. We estimate full-year adjusted non-interest income in the range of $1.85 billion to $1.9 billion, slightly higher than our previous guidance, buoyed by a better outlook for rail as we anticipate sustained healthy trends driven by a supply-driven recovery generating strong demand for existing rail cars, yielding a robust scenario. We also forecast higher service charge fee income from increased lending-related fees in light of strong loan volume. Regarding expenses, we expect a modest increase from the second quarter due to marketing expenditures aimed at replenishing time deposit runoff in the direct bank, along with professional fees and temporary staffing as project spending ramps up for several regulatory initiatives. Moreover, as previously mentioned, we are continuing to enhance our risk and technology capabilities, making strategic hires that lead to higher salaries and benefits expenditures. All these will be partially offset by the ongoing synergies from the acquisition previously discussed. We expect to achieve the lower 25% band of our cost base target by the end of 2024. These savings will be offset by continued capability enhancements for regulatory requirements and strategic investments aimed at maximizing growth in our core business areas and optimizing our systems and processes. The adjusted efficiency ratio is expected to remain in the low 50% range in 2024. In the long term, particularly if we enter a rate step cycle, we expect it to gravitate towards the mid-50s due to net interest margin compression and ongoing investments in scalable efficiency for future readiness as we approach category three status. Looking ahead, we estimate adjusted non-interest expense will be in the range of $4.65 billion to $4.7 billion, consistent with our previous guidance. For both the third quarter and the full year 2024, we anticipate our tax rate to fall between 27% and 28%, exclusive of any one-time items. To summarize, we are very pleased with our performance this quarter and will initiate our share repurchase plan shortly. As indicated by Frank’s earlier comments, we will continue prudent growth while aligning our capital allocation with our long-term goals and robust risk management practices. I will now turn it over to the operator for Q&A instructions.

Operator, Operator

Our first question comes from Steven Alexopoulos from JP Morgan. Steven, please go ahead. Your line is open.

Steven Alexopoulos, Analyst

I want to start with the stock buyback, and I understand you aim to reach the 10.5% CET-1 target by the end of 2025. Based on our calculations, $3.5 billion in buybacks through 2025 would keep you above 10.5%. I'm just curious, according to your calculations, does $3.5 billion in buybacks through the end of 2025 get you to 10.5% CET-1?

Craig Nix, CFO

Steve, this plan puts us on a path to reach the CET-1 in the 10.5% range by the end of 2025. We anticipate the plan will be executed over the next four to five quarters, and we will be updating our capital plan in the first half of next year. So, you're right, and the ratios would be elevated, all things being equal right now, but to the extent that earnings accretion continues to outpace organic growth, we do contemplate another share repurchase plan in the back half of 2025. So, yes, if we stop here, they would be there. But we are giving ourselves room for organic growth. We will assess our capital plan and if we are again, creating earnings faster than organic growth, we would contemplate another plan to guide us down to that 10.5% range by the end of 2025.

Steven Alexopoulos, Analyst

Got it. Just given the valuation of the stock here, how do you think about front-loading the buybacks? Like do you think it'll be pretty even? I mean, I know your incentive system's tangible book value growth based. What are your thoughts on that?

Frank Holding, Chairman and CEO

Well, we would obviously plan to front load, especially if we anticipate the stock price to continue to increase over time as our tangible book value increases. So, our plan is methodical but does have a heavier emphasis on the last half of '24. It's really not a straight line, but it is expected to occur over the next four to five quarters.

Steven Alexopoulos, Analyst

And then for my follow-up question, I'm curious, so the NII outlook — we know there are positives and negatives, and loan growth is helping. NII has purchase accounting accretion, and now we have rate cuts in the forecast. But if I look, you're at $1.8 billion NII for 2Q '24, basically implying the same for 3Q and 4Q. And Craig, if I look at consensus for 2025, it basically has the $1.8 billion sort of being the run rate for the next, call it six quarters or so. I'm just curious, given the strategies you're looking at, you talked about maybe mitigating some of the asset sensitivity, given all of the puts and takes, do you see that as reasonable that NII trends just flattish over the next several quarters? Just curious directly how you see this playing out. Thank you.

Frank Holding, Chairman and CEO

If we're looking at the exit margin in the fourth quarter, with zero rate cuts, we would be up — this is net income exclusion; we would be up low to mid-single digits without any rate cuts. With one cut, we would be up low single digits, and with three we would be down low to mid-single digits in terms of net interest income.

Steven Alexopoulos, Analyst

Just so I understand, so if we get two, following the forward curve, which is two this year and four next year, where does that leave NII?

Frank Holding, Chairman and CEO

It leaves NII down low to mid-single digits from the fourth quarter '24 exit to the fourth quarter '25 exit. And that's a presumable outcome. With the accretion, it would be down mid to mid-single digits.

Operator, Operator

The next question comes from Christopher Marinac from Janney Montgomery. Chris, your line is open. Please go ahead.

Christopher Marinac, Analyst

Just wanted to talk about the capital levels and kind of what the lower bound may be as the buyback gets executed, and would you revisit that as next year unfolds?

Frank Holding, Chairman and CEO

We anticipate that if we execute this plan, the CET-1 ratio would be in the mid 11% range. If that happens and our capital plan is successful, we aim to implement another plan to manage those ratios down to the 10.5% level by the end of 2025.

Christopher Marinac, Analyst

And the timing for now for today's authorization is to do this in the next 12 months, Craig, or would it be really 18?

Craig Nix, CFO

We're looking at four to five quarters in our pro formas. Tom, do you want to comment on that?

Tom Eklund, Executive

Craig mentioned we're slightly frontloaded in the plan but still trying to space it out over the next four to five quarters and wrap it up and really get on that large bank capital planning cycle and sort of reassess again in the first half of next year and then hopefully come back with a new plan.

Christopher Marinac, Analyst

Thank you, and just a quick follow-up on the venture capital space. Do you see any improvement there as you look through the next few quarters?

Craig Nix, CFO

It remains a bit mixed in terms of the outlook for venture investment. We saw a nice uptick this quarter to $55.6 billion, which was initially encouraging, but if you peel that number apart, there were two very big investments in there that, net of those, makes for a quarter that looked a lot like '23 and in the first quarter of '24. And so, there's certainly a lot of optimism out there; we have not yet seen it translate, and it's really unclear if we'll see that over the next couple of quarters at this time.

Operator, Operator

Next question comes from Casey Haire from Jefferies. Casey, your line is open. Please go ahead.

Casey Haire, Analyst

Great. Thanks. Good morning, everyone. Wanted to touch on the loan to deposit ratio. It did tick up here a little bit in the quarter on some pretty nice loan growth. I know you guys have a long-term goal to drive that lower. If SVB kind of returned to form the 165% level currently, obviously that would go a long way. Just wondering, can you comment on how the SVB depositors, deposits are behaving, like your ability to drive that loan to deposit ratio back to what was a very deposit-rich vertical and help you achieve these targets?

Frank Holding, Chairman and CEO

I'll start; maybe Tom can amplify here. We started the acquisition around 99% loan-to-deposit. It did pick up from 90% to 92%. So, we're making really good progress, getting it to our sort of mid-eighties target range. And we feel confident that over the next 3.5 years, as we work down this purchase money net debt from the FDIC, that we can achieve that range. Tom, do you have any comments on that?

Tom Eklund, Executive

Only thing I'd add on the SVB side, I mean we're obviously encouraged; we saw deposit growth during the quarter, that being said, we're looking holistically at the client relationship there, making sure we put them in the right products, you see off-balance sheet products when they're better suited for the clients. So, we're not binary narrowly focused on the deposit growth there. We're also looking at, as Craig mentioned earlier, general banks to drive up a portion of that growth needed as well.

Frank Holding, Chairman and CEO

Keep in mind, given that SVB deposits can be sort of transitory, especially in this environment, the direct bank is a lever we can pull as well.

Casey Haire, Analyst

Thank you. And then just my follow up on the, you guys mentioned that you've moved $5 billion into the bond portfolio to sort of dampen the asset sensitivity profile. Is there anything more that you can do on that front to mitigate the impact from Fed cuts?

Craig Nix, CFO

Our asset sensitivity, we embarked on this four quarters ago. Our asset sensitivity was around 20% in a 200-basis point rate shift; we've got that down to around 14% with these actions. That's about two-thirds of the path to where we'd like to be, which is somewhere in the 10% to 12% range. So, we're very close to that as we sit here today, and that 10% to 12% range is where we were pre-SVB. I think we're making good progress there and we are TBD focused. So, what happens there? Rates going down 200 basis points will have about a billion-dollar shot to net income. However, on the AOCI side, it would more than compensate with increased value of the investment portfolio to TBD where, where a balance sheet position would be neutral. Tom, is there anything else you'd like to add?

Tom Eklund, Executive

The only thing I'd add is, is tactically we did add some hedges during the quarter as well. We put on $2.5 billion for the cash flow hedging on the variable rates, moving some of that pricing out over the next 12 months.

Craig Nix, CFO

Ranges to that to $4 billion.

Operator, Operator

Now that we have no further questions, I will hand the call back to Deanna Hart for any concluding remarks.

Deanna Hart, Senior Vice President of Investor Relations

Thank you, everyone for joining us today, and we hope you have a great day. Thanks.

Operator, Operator

This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.