Citizens Financial Group Inc. (CFG) Q1 2021 Earnings Call Transcript

Citizens Financial Group Inc. (NYSE: CFG) Q1 2021 earnings call dated Apr. 16, 2021

Corporate Participants:

Kristin Silberberg — Executive Vice President, Investor Relations

Bruce Van Saun — Chairman and Chief Executive Officer

John F. Woods — Vice Chairman and Chief Financial Officer

Brendan Coughlin — Head of Consumer Banking

Analysts:

Matt O’Connor — Deutsche Bank — Analyst

Erika Najarian — Bank of America Merrill Lynch — Analyst

John Pancari — Evercore ISI — Analyst

Peter Winter — Wedbush Securities — Analyst

Ken Zerbe — Morgan Stanley — Analyst

Scott Siefers — Piper Sandler — Analyst

Amanda Larsen — Jefferies — Analyst

Bill Carcache — Wolfe Research — Analyst

Saul Martinez — UBS — Analyst

Presentation:

Operator

Good morning, everyone, and welcome to Citizens Financial Group First Quarter 2021 Earnings Conference Call. My name is Alan, and I’ll be your operator today. [Operator Instructions]

Now I’ll turn the call over to Kristin Silberberg, Executive Vice President, Investor Relations. Kristin, you may begin.

Kristin Silberberg — Executive Vice President, Investor Relations

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 first quarter results, referencing our presentation, which you can find on our Investor Relations website. After the presentation, we’ll be happy to take questions. Brendan Coughlin, Head of Consumer Banking, also here to provide additional color. Don McCree, Head of Commercial Banking, who usually joins us, had the personal conflict today.

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 also reference non-GAAP financial measures. So it’s important to review our GAAP results on Page 3 of the presentation and the reconciliation in the appendix.

With that, I will hand over to Bruce.

Bruce Van Saun — Chairman and Chief Executive Officer

Thanks, Kristin. Good morning, everyone. Thanks for joining our call today. We’re pleased to get off to a good start to 2021 as our business model continues to demonstrate strength, diversification and resilience, notwithstanding continuing impacts from the pandemic. We continue to focus on taking good care of customers, highlighted by $1.8 billion of PPP loans in the latest round of the program. We’ve kept our colleagues safe and productive. And we continue to drive benefits to our communities through various grants and strong levels of volunteerism. Our strategic initiatives remain on track and will lead to increasing differentiation and growth in franchise value versus peers over time.

Our financial headlines are terrific, though they’re flattered by a large reserve release given the improved economic outlook. We delivered underlying Q1 EPS of $1.41 and ROTCE of 17.6%, while our CET1 ratio grew to 10.1% and our liquidity remains elevated with an 81% quarter-end loan-to-deposit ratio. The first half of the year can be thought of as a transition period for us in terms of PPNR as the record levels of mortgage revenues normalize.

While we are still seeing strong levels of originations, both refi and purchase, elevated margins have been returning to historical levels as industry capacity has expanded and competition has intensified. We currently expect mortgage revenues broadly to bottom in Q2 and then stabilize in the second half. During the first quarter, we saw strength in capital markets and wealth fees, which partially offset the drop in mortgage fees. This should continue into Q2 and we should start to see loan growth pick up as well, which provides a further offset.

The outlook for the second half PPNR is strengthening as we expect loan growth plus the stabilized NIM given the steeper curve to help deliver top-line growth. This combined with strong pull-through of our TOP benefits and overall expense discipline should result in healthy levels of positive operating leverage in Q3, Q4 and the second half, along with return to solid PPNR growth. The outlook for credit also continues to brighten. With a negative provision of $140 million in the first quarter, our ACL ratio ex-PPP loans is now 2.03%. This compares with our day one ACL upon CECL adoption of 1.47%. So there’s likely still more to go and reserve releasing assuming the economic outlook continues to firm and clarify. All of our credit trends continue to be favorable, both on the consumer and commercial side. We’ve moved our charge-off guidance for full year 2021 to 35 to 45 basis points from the initial guidance of 50 to 65 basis points.

So to sum up, we feel we’re off to a great start. The economic outlook continues to improve. And we are executing well on the initiatives that will position us over time as a top performing bank.

With that, I’ll turn it over to John.

John F. Woods — Vice Chairman and Chief Financial Officer

Thanks, Bruce, and good morning, everyone. Let me start with the headlines for the quarter. We reported underlying net income of $626 million and EPS of $1.41. Our underlying ROTCE for the quarter was 17.6%, which includes the impact of a sizable reserve release. Revenue of $1.7 billion was broadly stable year-over-year, strong fee income offsetting the impact of the low rate environment on NII.

Highlights include continued strength in capital markets, record results in wealth and well controlled expenses. We’ve recorded a negative provision for credit losses of $140 million, which reflects strong credit performance with lower charge-offs and improving loan portfolio profile and an improving macroeconomic outlook with our ACL ratio now at 2.0% excluding PPP loans. And finally, we are in a very strong capital position with CET1 at 10.1% after returning $262 million to shareholders in dividends and share repurchases during the quarter. We also continued to grow our tangible book value per share, which was $32.79 at quarter-end, up 3% compared with a year ago.

Next, I’ll refer to a few of the slides and give you some key takeaways for the first quarter. I’ll then outline our outlook for the second quarter and provide some comments on 2021.

Net interest income on Slide 6 was down 1% linked-quarter given lower day count. Loan balances were broadly stable, and net interest margin was up slightly. The net interest margin improvement reflects a steepening yield curve and continued discipline on deposit pricing. Interest-bearing deposit costs are down 7 basis points to 20 basis points, which more than offset the impact of lower asset yields. We expected elevated deposit levels from recent stimulus will continue to impact margin in the near-term. We will continue to be proactive in pricing down deposits and pursuing attractive loan growth opportunities in areas like point-of-sale finance and education as well as in attractive commercial segments.

The steepening of the curve provided us with the opportunity to begin adding to our hedge positions to moderate our asset sensitivity. We added $7 billion of five year receive-fixed cash flow swaps and terminated some pay-fixed swaps during the course of the quarter. Those actions combined with expected balance sheet changes, reduced our asset sensitivity to about 8.5% from 10.8% at the end of the year.

Referring to Slide 7, we delivered solid fee results again this quarter, reflecting our ongoing efforts to invest in and diversify our revenue streams. As expected, mortgage fees were down approximately 15% this quarter despite strong volumes as heightened competition and increased industry capacity pressured gain on sale margins. Nonetheless, mortgage fees were still strong compared to a year ago. And we expect a continued strong level of originations across all channels over 2021 as the market shifts to being more balanced between refi and purchase activities.

2021 is expected to be the strongest home purchase market in history, only restrained by housing inventory. Wealth fees were a record, up 12% linked-quarter, reflecting an increase in AUM from net inflows and strong market levels with record sales. Capital markets fees remained robust, though they were down 8% from a record level in the fourth quarter with lower M&A advisory fees, partly offset by increased underwriting revenue. Foreign exchange and interest rate products revenue decreased $7 million linked-quarter given reduced client hedging as a result of less lending activity and lower volatility.

Expenses on Slide 8 were well controlled, up 3% linked-quarter, driven by seasonality in salaries and employee benefits. We are continuing to focus on both the transformational and business as usual aspects of our TOP6 program. And we are on track to deliver total pre-tax run rate benefit of $400 million to $425 million by the end of 2021.

Average loans on Slide 9 were broadly stable linked-quarter as commercial pay-offs and slightly lower line utilization of about 32% compared with the historical average of roughly 37% was partially offset by growth in our education, mortgage and point-of-sale finance portfolios. Looking at year-over-year trends, average loans were up approximately 1% due to PPP, education and mortgage. We executed the PPP lending program very smoothly with $1.8 billion of loans secured as part of Round 2, taking the total PPP loans to $5.1 billion at period end. We expect that about 85% of the Round 1 loans will be forgiven by the end of the year. And for Round 2, which are five year loans, about 20% could be forgiven by the end of ’21 and about 70% forgiven after two years. Overall, the PPP program will help stabilize NII in the first half of the year, while the benefit will taper off a little in the second half.

On Slide 10, deposit flows benefited from the recent consumer-oriented stimulus, especially in low cost categories and our liquidity ratios remained strong. Average deposits were up 1% linked-quarter and 16% year-over-year as consumers and small businesses benefited from government stimulus and commercial clients build liquidity. We are very pleased with our progress on deposit repricing with total deposit costs down 5 basis points to 14 basis points and interest-bearing deposit costs down 7 basis points to 20 basis points during the quarter.

We continue to drive a shift towards lower cost categories with DDA now about 30% of average deposits compared with only 23% a year ago. The strength of our deposit franchise is becoming very clear given all the investments we’ve made, including the launch of our digital bank, enhanced data analytics and introducing new cash management tools for our commercial clients. At the end of the last low rate cycle in 2015, our interest-bearing deposit costs bottomed at about 34 basis points. This cycle, we are already at 20 basis points, and we expect these costs to decrease to the low-teens by the end of the year as we execute our deposit playbook.

Moving on to credit on Slides 11 and 12. We saw strong credit results this quarter. Net charge-offs were down 9 basis points to 52 basis points linked-quarter. This is at the lower end of our guidance for the first quarter and driven by a reduction in commercial. First quarter commercial net charge-offs included charge-offs in areas of market concern, including pre-retail, casual dining and one large charge-off related to a financial sponsor.

Non-accrual loans decreased $11 million linked-quarter with a $76 million increase in commercial driven by charge-offs, loan sales activity and repayments. Retail non-accrual loans increased by $65 million linked-quarter driven by mortgage loans coming off forbearance. However, given the strength of the housing market with inventories at historical lows and strong LTVs in our book, we expect little to no loss [Phonetic] content in these mortgages.

In addition, our commercial criticized loans continued to trend down this quarter, decreasing by $495 million or 11%. Given the improvement in the macroeconomic outlook and performance of the portfolio, our reserves decreased, but remained robust, ending the quarter at 2.03% excluding PPP loans compared with 2.24% at the end of the fourth quarter. This is still significantly higher than our 1.47% day one CECL implementation coverage. We anticipate there likely will be further reserve releases assuming the macroeconomic outlook continues to strengthen and solidify.

We have some detailed credit slides in the appendix for your reference. One on Slide 22 covering commercial credit. Since the start of the COVID 19 crisis, we have been highlighting the commercial areas most impacted by the lockdowns. As we continue to see improvements in the operating environment, these areas of concern have now decreased to 2.3% of the total CFG loan portfolio, down from 4.6% in 4Q ’20 and approximately 11% in 1Q ’20. The remaining areas of concern include CRE retail and hospitality, casual dining and arts, entertainment and recreation. And accordingly, we are maintaining prudent reserve allocations with a reserve coverage of about 10% for these areas.

We maintained excellent balance sheet strength, as shown on Slide 13, increasing our CET1 ratio from 10% in 4Q to 10.1% at the end of the first quarter, which is slightly above our target operating range after returning $262 million in capital to shareholders in the quarter.

Before I move on to our 2Q outlook, let me highlight some exciting things that are happening across the company on Slide 14. On the left side of the page, we were very pleased to be able to provide about $1.8 billion in new PPP loans through the latest SBA program, providing critical funding to over 30,000 of our small business customers. On the consumer side, we’ve recently announced the expansion of our national point-of-sale offering for merchants through our Citizens Pay offering. We are continuing to add new merchants to our point-of-sale platform, such as BJ’s Wholesale Club with more in the pipeline and the portfolio is up 8% year-over-year.

In addition, we continue to make great strides in our digital transformation with our digital sales up 48% year-over-year. Clearly, our customers are demanding a different distribution model from us, one that allows for more efficient digital transactions and an advice-oriented focus in our branches. We launched our new mobile app on iOS in January, which is receiving great reviews with an average of 4.6 stars in the App Store.

In commercial, we have built out a robust corporate finance advisory model, which is supporting our geographic expansion efforts. Our capital markets business delivered its second best quarter ever in the first quarter, demonstrating the benefits of the investments we’ve made over the last few years. On the right on page you can see a high level view of our strategic priorities, all of which remain on track.

And now for some high level commentary on the outlook for the second quarter on Slide 15. We expect NII to be up 2% to 2.5% with NIM up modestly, more broadly stable excluding elevated cash. We expect loan growth of 1.5% to 2% in the second quarter followed by an acceleration in the back of the year. Earning assets are expected to be broadly stable in the second quarter. Fee income is expected to be down high-single-digits, reflecting lower mortgage banking fees as gain on sale margins decline further towards more normal levels, partially offset by strength across many of the remaining fee categories. Non-interest expense is expected to be down slightly. We expect net charge-offs will be in the range of 30 to 40 basis points of average loans with a meaningful reserve release through provision.

Before I wrap up, I’d like to provide some comments on this transition period towards economic recovery and our 2021 full year outlook. First, we remain confident in our 2021 PPNR outlook with NII higher and fees slightly lower than our original guidance. Let me give you some further color on the puts and takes. We’re expecting loan growth to really pick up in 2H ’21, driven by student, point-of-sale, auto and mortgage as well as commercial utilization starting to rise from historical lows as the economy finds stable footing and companies begin to invest for growth. Coupled with a steeper yield curve, this improves our NII outlook.

Our outlook for fees is slightly lower driven by mortgage as we expect additional pressure on gain on sale margins as they begin to migrate lower. As the curve steepens, we should see a transition to greater contributions from purchase originations and servicing. We have included some additional detail on the mortgage landscape in the appendix on Slide 20.

We expect other fee categories, namely capital and global markets and wealth to continue to be strong as we leverage our investments and the economy rebounds. Other categories like card fees and service charges and fees should also benefit as consumer confidence and spending picks up. Given these dynamics, we expect PPNR to bottom in the second quarter and then rebound to levels higher than the first quarter for the remainder of the year given strength in NII and fees as well as well controlled expenses.

We also expect to be close to neutral operating leverage in 2Q compared to 1Q followed by meaningful positive operating leverage in the second half. We are also expecting a substantially better credit outlook for the full year. Given the strong performance of the loan portfolio and improvement in the macroeconomic forecast, we are reducing our full year charge-off guidance range to 35 to 45 basis points. And with this improvement, we could also see our ACL ratio decline meaningfully from the current 2.3% — 2.03% ex-PPP.

To wrap up, this was a strong start to 2021 for Citizens as we begin to transition away from the effects of the pandemic to an improving outlook for interest rates and economic growth, all while staying focused on executing across our strategic initiatives.

With that, I’ll hand it back over to Bruce.

Bruce Van Saun — Chairman and Chief Executive Officer

All right. Thanks, John. Operator, let’s open it up to Q&A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question will come from the line of Matt O’Connor with Deutsche Bank. Go ahead.

Matt O’Connor — Deutsche Bank — Analyst

Good morning. Your outlook for loan growth is a bit better than what we’ve heard so far from other folks. And I was just wondering if you could elaborate on the drivers both in the near-term and then how robust you think loan growth can be kind of when things fully reopen, call it, later this year into next year?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I’ll start off with that, Matt, others may weigh in here. But in the near-term, I think that the strength that we’re seeing is really attributable to our diversified consumer lending and retail businesses. When you see what we’ve been able to do in the mortgage portfolio, auto and education, I think those are areas that have been areas of strength in the past and will continue to be in the second quarter.

I also believe that when we get into the second quarter, you’re going to start to see, although across the industry we see utilization levels come down a bit in the first quarter, I think we believe that that will start to moderate and stabilize and possibly start to head back up off of historic lows — historic low level, so you can see commercial contributing as well in the second quarter.

And as you — that will create the staging ground, if you will, for what we see in the second half where the continuing expectations for reopening economic activity accelerating. On the commercial side, inventories building, capex expenditures starting to recover and increase. So those are the forces that we see in terms of loan growth throughout the year.

Brendan Coughlin — Head of Consumer Banking

Yeah. On the consumer side — thanks, John. I’d offer a couple of thoughts. One, across all the asset categories — unwound credit tightening that we did through COVID. And so we haven’t changed our risk appetite, but we — the temporary tightenings that we did, those are now broadly unwound. So we should see originations tick up across all categories. We’ve also turned on marketing that we had artificially suppressed last year as well.

Asset-by-asset, I think I had mentioned last quarter, we had sort of put auto in a flattish trend intentionally. The market always allowed for us to grow, but we were optimizing our balance sheet with all the excess deposits we have now in the short duration, we’re finding incredibly high returns in the auto business. So you should expect that to continue to moderately grow assuming that the environment allows for outsized returns, which we’re not seeing slow down.

On the student side, we have a record quarter in our student refinance product over $900 million in originations. That could moderate a tiny bit, but still at record levels giving high rates. And as the federal portfolio of student loans come off their forbearance in September that will provide another opportunity for growth. And then seasonally our in-school business, we’re expecting a very big year as a lot of students took the year off given COVID, a big freshman class coming in and just seasonal growth in the summer and the fall.

And lastly, point-of-sale is an area that you know we’ve spent a lot of time and investment in. We’ve got great traction. We’re up to about 15 partners. So we’re in the build phase there, whereas these partners ramp you’re naturally getting sort of outsized growth for the loss small numbers as the portfolio gets to scale. So I’ve got a lot of confidence in the outlook in consumer growth. And underpinning that is obviously improvement in consumer confidence.

Bruce Van Saun — Chairman and Chief Executive Officer

I would just add, it’s Bruce, Matt, just one last proof point on the commercial side. In addition to line utilization, we’re just seeing activity start to build. So our pipelines are much stronger at this point than they were early in the first quarter. So that’s a good sign of both economic activity, backlogs in M&A still pretty high. So we see line utilization kicking in plus just fresh deals, and we continue to add bankers and grow our market share.

Matt O’Connor — Deutsche Bank — Analyst

And is most of the demand build in commercial related to deals, as you just referenced or is there also kind of some early signs of increased, call it, organic investment among commercial borrowers?

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah. I think there’s is some of both, Matt, quite honestly. So right now, you can see the economic stats are fantastic, and so people are positioning to try to capture that demand. And so that means increase in supply, which require some capital investment. And then also labor, bringing people back to work, which frankly when we talk to many of our corporate customers has been a gating factor. It’s hard to actually fill out their needs, and we’re trying to be helpful on that with some initiatives around workforce development, but the animal spirits are starting to kick in here.

Matt O’Connor — Deutsche Bank — Analyst

Okay. Thank you.

Operator

We will move next to the line of Erika Najarian with Bank of America. Go ahead, please.

Erika Najarian — Bank of America Merrill Lynch — Analyst

Hi, good morning. A follow-up to Matt’s question, because I want to make sure the market really understands this. A lot of your larger peers that where the consumer exposure is more credit card-related, really talk to us over the past couple of days about how deleveraging was going to negatively impact demand. And perhaps maybe give us a little bit more detail about why you’re consumer products are not necessarily going to be impacted the same as credit card?

Brendan Coughlin — Head of Consumer Banking

Yeah. Hey Erika, thanks. It’s Brendan. I’d just say our credit card book is significantly smaller than our peers on average basis to our overall loan book. And so we are seeing a little bit of those dynamics in our credit card portfolio. We’re not calling for growth in credit card, but that delevering of our card book with all the extra stimulus has a much more muted impact for us on our overall consumer lending portfolio than others, just given the relative under-sized nature of our card book.

So we found opportunities to grow in more niche places like point-of-sale, which is the demand is generated by purchase activity. And as the economy rebounds, consumer confidence comes back, folks are out there buying bigger ticket items again and the point-of-sale business is there to help and very naturally lined up against the recovery of consumer spending on how we think about modern financing for consumers. And while rates are going up, they are still very, very low. And so I look at student loan refinancing, as I mentioned before, as something that’s still going to be very, very strong. There is a lot of customers that are in new money. That’s a product that our peers, generally speaking, don’t have. And so that’s generating outsized growth for us.

And similarly in student, the in-school business, as I mentioned before, seasonally just naturally that we’re going to have some growth just by being in that business in the back half of the year, which most of our peers don’t have. In auto, again not to be too redundant, but we had intentionally signed line autos. We’re back in growth mode there at a moderate level. So when you add all that up, I think we’ve got a lot of confidence that we’re going to buck the trends that you’re hearing from others, and we’re proving. The numbers show in the last handful of quarters that we’re already delivering it even through the COVID period.

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah. I would just add to that. Diversification is important. And so we have probably more portfolios and some well-targeted portfolios in niches that should continue to still grow. So that’s I think why we’ll kind of buck the tied a little bit overall. And I would just add also that the outlook for the so-called buy now pay later or installment financing kind of tailoring products to people at point-of-sale is very, very positive. So I think the industry forecast for that is 20% growth over the next five years and on card, it’s much, much lower. First you have to get the rebound upon. I think your low-single-digit in terms of the growth outlook there. So I think we’ve made a bet that this is going to be a burgeoning attractive area that we’re well positioned to catch some wind here.

Erika Najarian — Bank of America Merrill Lynch — Analyst

And my second question is on the margin outlook for the second quarter and perhaps a little bit beyond. Thank you for giving us an update on how you’re expecting PPP to unfold for the rest of the year. I’m wondering in the NIM up modestly guide, how much forgiveness is assumed for the second quarter? And also maybe give an outlook on how you’re thinking about redeploying the excess cash for the rest of the year?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I’ll go ahead and take that, Erika. I mean, I think just to focus on the second quarter, I think that the rate environment is favorable to us and others. But I think that we’re seeing nice tailwinds from the rate long and rise. I’d also reference the fact that we’ve added to our hedge portfolio in the first quarter, and that’s contributing. And I think we’ll get a full quarter effect of that in the second quarter. And just our overall mix on both the asset and deposit side, so greater DDA in the first quarter and that’s flowing into the second quarter.

And don’t forget some of the comments I made earlier about our deposit costs, that’s a lever that continues to contribute. And those are some of the important I think drivers into 2Q with more room to run there. The 20 basis points coming down to sort of into the teens into the second quarter into the low-teens as you get to the end of the year. So those are some of the forces. PPP is less of less of a contributor. It’s pretty — as we mentioned, it stabilizes overall NII. But in terms of NIM, there is no real meaningful difference between forgiveness last quarter versus this quarter or next quarter. So it’s really not a driver over the last quarter or next.

Erika Najarian — Bank of America Merrill Lynch — Analyst

Got it. Just to clarify, so the forces that are driving NIM higher in the second quarter are sort of core business trends and not PPP?

John F. Woods — Vice Chairman and Chief Financial Officer

They are rates, rates balance sheet, balance sheet mix, deposit pricing and loan growth. Those are the things that were really driving this.

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah. And just a further word on PPP. I mean, John called it right, but that’s been pretty stable through the back half of last year through the first half of this year. If you look at the yields on those loans with forgiveness baked in, it’s not a big winner for the bank. So what we had anticipated was that we’d start to see some fall off given the new program that was added. The glide path down in the second half of the year is much less severe. So I don’t think the PPP this year will be a huge factor compared to last year on any sequential quarter that we would have to call out.

Erika Najarian — Bank of America Merrill Lynch — Analyst

Got it. Thank you so much.

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah.

Operator

We will go next to the line of John Pancari with Evercore ISI. Your line is open.

John Pancari — Evercore ISI — Analyst

Good morning.

Bruce Van Saun — Chairman and Chief Executive Officer

Hi.

John F. Woods — Vice Chairman and Chief Financial Officer

Good morning.

John Pancari — Evercore ISI — Analyst

Regarding your commentary on the operating leverage expectation for improvement and for I think you referenced it as healthy level of operating leverage. Any way you could help us think about the magnitude in terms of sizing that up? What type of level of operating leverage you think is achievable in the back half? And then what would that could possibly mean for 2022 as you look out?

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah. So historically, if you look at what we were able to deliver since the IPO, we’ve probably been in a 300 basis points of operating leverage type mode and whether that was 6% or 7% revenue growth and then 3% or 4% expense growth, it’s kind of scaled with what the revenue environment is. We’re trying to compress the expenses to try to maintain something like that. And so clearly that would be our objective over time.

And as John indicated, we’re kind of working through a transitory phase where the mortgage revenue has the reset. It was a huge boon for last year. We did 400 basis points of operating leverage for all of last year, which was fueled by mortgage. So in the first half of the year as that normalizes, that makes it hard to deliver the positive operating leverage, although we did state in our guidance that we should come pretty close to neutral in the second quarter, notwithstanding that kind of last leg to drop on mortgage revenues before it stabilizes.

Once we can get back to kind of having that mortgage bottom out, and we’re seeing nice growth in our fees, we’re seeing our balance sheet grow, we’re seeing good performance on NIM, then we should get back to having a nice top-line, and you can count on us to continue to constrain the expense growth. We’ve done, I think, a really good job with the TOP program of repositioning citizens to be much more equipped for the future in terms of our technology. So we have a next-gen technology element to that project. We have huge going digital — going to a digital first business model going to that. So those require investments, but our mindset all along has been to self-fund to try to find the inefficiencies in how we’re running the place, ring those out and then in turn go reinvest those. And I think we’ve demonstrated over time that we’re quite good at that. So we’re managing expense base tightly, but we’re certainly keeping up with the investments that we need to position us for future growth.

John Pancari — Evercore ISI — Analyst

Great. Thanks, Bruce. That’s helpful. And then separately on the consumer side, on the merchant partner side, kind of a two-parter. First, just want to see if you can give us a little bit of color around the risk adjusted returns you’re able to get in that business in terms of maybe the loan yield that you’re seeing on your partnerships as well as the loss assumptions. And then separately, I know you mentioned, buy now pay later, Bruce, interested if you believe you need more scale there to take advantage of the opportunity or if you need more capabilities on the digital front, and therefore, would you be open to an acquisition to give you greater scale or do you think the momentum you have already in the area is sufficient? Thanks.

Brendan Coughlin — Head of Consumer Banking

Yeah, thanks. It’s Brendan. I’d say, the risk adjusted returns on the point-of-sale business, the way you should think about it is it’s equivalent to a credit card profile. The geography is a little different. The yields are a little bit lower and the losses are meaningfully lower. But the returns are equivalent to what you’d expect on a prime card portfolio, which is why we sort of disclosed them all in the same bucket of other retail, which is great because if you think about that, if you’re getting equivalent credit card returns, but lower losses that are going to perform even better through the cycle, that’s a very, very attractive place to play.

And as I’ve shared in the past, when you look at the credit performance of point-of-sales through COVID, forbearance was basically non-existent and delinquencies were down from pre-COVID levels. So that portfolio is operating as if there was no recession or lockdown going on around us. And so we’re incredibly excited about that dynamic and we don’t think it was artificially created. The customer experience was so slick and integrated into consumers’ top wallet payment that really we’re kind of getting that TOP payment position in that product. So very, very excited about that.

Relative to acquisition, look, we’re really bullish on our capabilities. We think it’s very distinctive from what others offer in this space. The old school traditional buy now pay later players and even relative to some of the fintechs where we’ve got a unique niche that we’ve also have the balance sheet, we don’t have to upload these loans, allows for a lot more creativity and innovation on how we structure the product. As an example, like the Apple product where a revolving purchase where the customer gets the new phone every year, that’s hard to do if you’re reliant on capital markets to fund your business model. So we’re excited about the business model. If there was an acquisition that could help us accelerate at the right price, of course, we would look at it. But I don’t think we need one to get scale.

John Pancari — Evercore ISI — Analyst

Great. Thank you. Appreciate you taking the questions.

Operator

We’ll go next to Peter Winter with Wedbush Securities. Go ahead.

Peter Winter — Wedbush Securities — Analyst

Good morning. I wanted to ask about the average securities yield, I noticed it held steady quarter-to-quarter. And I’m just wondering what the new reinvestment rate is on the securities? And secondly, if you’re extending duration on that portfolio?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I mean, I’ll take the last question first. I mean, I think that, as you know, most of our portfolio is in mortgage-backed security agencies — agency space. And so really that’s a rate-driven outcome and pretty typical, as you would see. As rates rise, prepayments slow and so those mortgage-backs will extend in duration. And so that’s really what’s going on there. We didn’t actually through our purchase activity endeavor to extended duration. That was just an impact of the macro on the securities that we have.

I mean, I think the way that we look at the securities book, it’s basically, a few weeks ago, I might have said that our reinvestment yields could have been in the neighborhood of 175 to 180 and might have been close to where the run-off yields would be. But over the last couple of weeks, as you’ve seen the rally in rates, we’re sort of in the, I’ll call it, 160 range. And so it will be a negative front book, back book, probably in the early part of the second quarter. But as you get into the end of the third quarter, based upon what we see, you can start to see securities portfolio being the first sort of term book that starts to get to neutral on front book backlog and begins to become a positive contributor into the second half. And I’d say more broadly, those are the kind — that’s the kind of dynamic you’ll see with other loan categories as one by one you will see improvements on that front.

The other thing, again back to this is a broader NII NIM story, but if we believe where rates are headed and the forces all indicate that we’ll get to higher long-term rates as you get to the end of the year, we’ll continue to layer in our swaps and our swap hedging program as well, which will also contribute to NII and…

Bruce Van Saun — Chairman and Chief Executive Officer

It have a faster impact when you start to see the curve steepening through swaps.

John F. Woods — Vice Chairman and Chief Financial Officer

Exactly. So front book backlog converts from it as the headwinds were sort of a tailwind as you get to the end and into the second half. I mean, you can see our playbook on rate management all contributing to NII and NIM.

Peter Winter — Wedbush Securities — Analyst

Got it. Thank you. And then just on the allowance for credit losses. So I’m just wondering with the improvement in credit, how quickly do you think you can get back to that CECL day one level? And does that level change just because of the composition of the portfolio changing with more of the growth or more growth from consumer?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I’ll go ahead and take that. I mean, you’ve seen us come down relatively meaningfully this quarter. The way CECL works, if you had perfect knowledge about where the macro is headed, all of that good news and all of that expected outcome would all be built into our results this quarter. But you also should take into consideration the uncertainty around those expectations. And the uncertainty as we’re turning towards much more positive macro, that uncertainty in the range of potential outcomes is still very, very wide. And as a result, we have a number of overlays that are judgmental in nature that sort of work together with our model outputs to give you what our results are. So net-net, the balance would be that we have big releases happening now. If in fact the uncertainty around the base case begins to narrow, you could see our coverage getting closer to day one as you get into the second half and towards the end of the year.

Peter Winter — Wedbush Securities — Analyst

Right. Thanks.

Operator

We’ll go next to the line of Ken Zerbe with Morgan Stanley.

Ken Zerbe — Morgan Stanley — Analyst

Hi. Great, thanks. Good morning. I guess, the first question, just in terms of the swaps that you put on, can you just talk about the duration of those? I understand we’re sort of in a low rate environment, but at some point rates will rise. I’m just kind of curious how the timing of those swaps play out your expectations for Fed fund hikes at some point?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I mean, the duration is five years on the swaps that we put on with the $7 billion, and that’s relatively typical. I mean, you sort of look at this on a dollar cost averaging basis. When you see the fed five years, it’s really where a lot of this hedging happens. When you saw the five year go from 40 basis points to 90 basis points in a very short period of time, that’s a signal to trigger the first sort of tranche of hedging that you will do over time. And really we’re not — what you’re doing is you are reducing your downside when you start to layer hedges in.

And so our first tranche was triggered, it’s contributing in a positive way. It takes away and reduces the risk to lower rates over time, but we basically are — you pause after that first sort of category of hedging and you wait for the next sort of range of rates before you get into the next tranche. And so $7 billion is a fraction of what our overall hedging will be as you get to the end of the cycle. And so rather than waiting to pick the perfect spot maybe a year from now and do all of our hedging all at once, you tend to do it over time.

Bruce Van Saun — Chairman and Chief Executive Officer

Just leg into it. It tend to dollar cost averaging for you guys if you’re investing your portfolios.

John F. Woods — Vice Chairman and Chief Financial Officer

And the last — so the last tranche that you would do if and when the five year hits its peak and then if you have a big rally in rates that will widen out the first tranche that you do as you get towards the end of the five years if in fact rates continue to rise and rise and rise, then you have you have those turn negative. But those are more than offset by all of the positives of the hedging that you do as rates continue to rise.

Ken Zerbe — Morgan Stanley — Analyst

That makes perfect sense. And then just my second question in terms of capital, obviously, very strong CET1 at 10.1%. Can you just talk about your plans or expectations? Like, how does that eventually get absorbed? Now you can buy back stock, but it sounds like you’re also going to have stronger balance sheet growth?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I mean, I think we said this before, our program here and our number one capital objectives are to support the dividend and to support organic growth and putting capital to work in support of our customers and clients. So that’s really our first objective. And then if we can do that in a way that is additive and returns exceed our cost of capital, we think that’s the right thing to do for the franchise. And so that’s our focus.

As we mentioned earlier, we do have a transition to loan growth beginning in the second quarter. The average loan growth 1.5% to 2%, but spot loan growth in the second quarter will be higher than that. As things begin to accelerate, you could see 3% or better spot growth in the second quarter alone and seeing those numbers go higher still if the environment unfolds the way we expect. So that’s our focus. To the extent that we have excess capital even after supporting all of those things, then that’s when you get into how we look at returning it to shareholders through the form of buybacks and thinking in parallel about bolt-on fee acquisitions.

Ken Zerbe — Morgan Stanley — Analyst

All right. Thank you.

Operator

Our next question will be from Scott Siefers with Piper Sandler. Go ahead.

Scott Siefers — Piper Sandler — Analyst

Good morning, guys. Thanks for taking the question. I think first question, sort of a follow-up on the capital one from the prior question. Just given that your credit concerns are kind of melting away, is there any opportunity to maybe revisit your internal capital targets a little lower, a little higher than some of your peers and of course some of that I’m sure is just due to the complexion of the balance sheet. But nonetheless, with the risk profile improving just would be curious to hear any thoughts there?

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah, it’s Bruce. So we’ve, as you’re aware, have inched down over time. So I think initially we had 10.25% target as our CET1 ratio, and then we went to 10% to 10.25%, now we’re 9.75% to 10%. So I think initially coming out of the IPO as a relatively new company without a long-term track record, having a little higher CET1 targets than peers made sense. You’ve seen through the CCAR work that our credit losses stress at median or better, slightly better than median. And so there’s really not such a significant need any longer to carry that little extra cushion, although I do like to sleep well at night, a strong capital ratio helps with that.

But over time, we’ll see where the peer group goes. And if the peer group continues to inch down given the positive outlook for the sort of foreseeable future, there’s no reason that we couldn’t do that as well. But at this point, we’re locked in for this year with that 9.75% to 10% range. And I think that gives us plenty of fire power given the capital we’re generating potential for future reserve releases to pursue our agenda of the significant loan growth and potentially some fee-based acquisitions and also giving some back to our shareholders.

Scott Siefers — Piper Sandler — Analyst

Perfect. All right. Thank you. And then maybe, John, just sort of a follow-up on some of the actions you took regarding rate sensitivity in the first quarter. I think I can sort of back into some of it based on kind of what you said about duration and things like that. But I think you guys have said in the past here rate sensitivity is sort of 55-45 short end versus long end. Is there any meaningful change in how that looks now following some of those first-quarter actions?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah, not much of a difference. I’d maybe call it 60-40, but basically that’s about where we are, 60 short, 40 long, in terms of the complexion.

Scott Siefers — Piper Sandler — Analyst

Okay. Perfect. All right. Thank you very much, guys.

Bruce Van Saun — Chairman and Chief Executive Officer

Sure.

Operator

Next we’ll go to Ken Usdin with Jefferies. Your line is open.

Amanda Larsen — Jefferies — Analyst

Hey, guys. This is Amanda Larsen on for Ken. I guess on the loan growth outlook of 1.5% to 2%, I mean you did talk about the bucket. But if you can kind of just talk about the mix that you would expect of just commercial versus consumer in 2Q that would be helpful.

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I think that retail, I would describe it as it’s really going to be leading the way in the second quarter as commercial takes maybe — begins its margin and as the recovery really contributes to higher utilization and as those loan pipelines that you heard from Bruce earlier begin to sort of realize themselves. So I’d say in the second quarter, it’s probably, I don’t know, it’s something in the neighborhood of two-thirds, one-third of the majority coming from retail, but commercial clearly contributing and beginning to be a bigger contributor as you get into the second half of the year.

Bruce Van Saun — Chairman and Chief Executive Officer

I think you’ve got some — for average loan purposes, you’ve got to work through some of the dynamics of the first quarter. But what we’re pretty excited about is on a spot basis, we see significant growth in the second quarter which will set us up well for growth in the second half of the year. So the goal really in the second quarter is to really layer in that nice spot level of growth. It won’t fully manifest itself in the average numbers. So therefore we’re at that 1.5% to 2%. But it does — if we achieve it, set us up extremely well for the third quarter.

Amanda Larsen — Jefferies — Analyst

Okay, super. And then, John, can you just frame the conversation on swaps with how much you earned on cash flow hedges in the first quarter and then maybe what’s expected for 2Q and beyond assuming LIBOR is flat from here?

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. The way that we’ve talked about that in the past is really on a year-over-year basis given that the portfolio is contractual and you can sort of see it. We’ve talked last year based upon the portfolio that was in place at the time that year — from 2021 would be about a, call it, $75 million to $80 million decline in contribution from the swap portfolio versus 2020.

Just with the $7 billion that we put on in the first quarter that’s been cut in half. And so the headwind from swaps is really declining. If rates continue to rise from here, that number will continue to decline off of that level.

I think the broader point though is you can’t really look at it in isolation. You got to look at overall. As we indicated, net interest margin being broadly stable, excluding excess cash and frankly rising, if you consider what’s going on with deployment of cash and what’s happening with our expectations on loan growth. And another reminder on our deposit costs, that’s a lever that’s unique to us. We may have come down a little slower than others and — because we had a lot farther to come. And so like 20 basis points headed to so-called mid-teens in the second quarter, headed to low teens to the end of the year, that’s another driver. So in the big picture, including all of the swap dynamics, net interest margin appears to be stabilizing and will — is an improving picture going forward.

Bruce Van Saun — Chairman and Chief Executive Officer

It’s funny that what was the gap versus peers our [Phonetic] slightly higher deposit cost turns into a lever, turns into an asset when you’re going through this environment. So many of the peers have already reached levels that it’s hard to improve upon on their interest-bearing deposit costs, we just still have some room to run.

Amanda Larsen — Jefferies — Analyst

All cyclical. All right. Thank you so much.

Operator

We’ll go next to the line of Bill Carcache with Wolfe Research. Go ahead.

Bill Carcache — Wolfe Research — Analyst

Thank you. Good morning. I wanted to follow up on some of your earlier comments. You guys have a unique view given your mix of consumer versus commercial lending. Can you give a bit more color on how you see pent-up demand dynamics playing out across both groups as we make further progress into the reopening? It sounds like you think there’ll be a bit more gearing initially on the consumer risk commercial side. But I was hoping you could just to expand on that thought process and how does the excess liquidity that both groups have available play into that thinking?

Bruce Van Saun — Chairman and Chief Executive Officer

Go ahead.

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. I can start. Yeah. On the consumer side I think the growth that we’re projecting is sort of happening underlying right now. And we will get a bit of a tailwind from the reopening and consumer confidence growing. But the structure of our products are so diversified and naturally set up to give us outsized growth I had mentioned earlier. Student loan refinancing, you should think about that a lot like mortgage when rates are low. And even though they’re ticking up a little bit, they’re still historically low. That creates a boom of demand. That’s almost like stimulus, another form of stimulus for customers that we’re providing through restructuring their payments down. And so that just is naturally demanded now independent of the reopening.

Similarly with point of sale, I mentioned as the economy reopens, customers are starting to do big-ticket purchases. Again, we’re seeing our debit transaction average ticket go up pretty significantly. Those transactions are now up year-over-year. Very clear, consumers are starting to spend again which means point-of-sale financing is well positioned for growth. With the economy reopening, we’re seeing that anyway, even independent of another tick-up of the economy reopening. And auto has been a hot market. Auto industry sales are really, really high and the market is still bearing outsized returns. And so while [Indecipherable] good, we’re going to continue — we’ve got a diversified auto business. Number one JD Power in the country in auto. We’re very well positioned to grow that business in a well-controlled way with double-digit ROEs, which you don’t typically see with auto.

So yeah, I think as the economy reopens that should provide a bit of another nice tailwind but even at a moderately slow pace of the economy reopening, I still feel pretty good given the diversification of our business that we will get the growth that we’re calling for in consumer.

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah. And I would say we still would expect to see some elevated cash levels and a lot of times that’s kind of geared to folks who worked in the service industries and had loss of employment and are still kind of holding onto the precautionary cash levels given circumstances. So that will, I think, run down fairly gradually. But these are the factors that Brendan mentioned that are somewhat separate from that. They are not as impacted by kind of the stimulus money that’s been paid out.

And then I think on the commercial side, it’s really just a question of how fast folks take a positive view about the need to meet demand. If they see demand rising then they can start investing and then how do they finance that, they can use some of the big liquidity levels that they were able to amass. But I think you’ll see that corporate cash starting to drop some. But then going back and borrowing on lines is kind of the next phase that you would expect to see and then some special-purpose facilities to build a new plant or things like that or just the deals that continue to happen and the financing that goes with those acquisitions. So we would expect to see — we’re already starting to see that some of that cash is getting put to work and it really just depends on how fast the view about the current economic improvement solidifies.

Bill Carcache — Wolfe Research — Analyst

That’s helpful. Thank you. If I could follow up, do you think that the elevated payment rates that we’ve been seeing really on the consumer side broadly have peaked based on what you guys are seeing or particularly with the effects of the latest stimulus checks or — could those potentially remain elevated for a bit longer here before we start to see them come down and, I guess, contribute a bit more to some of that improvement in balances that you’re expecting?

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah. The elevated stimulus on prepayment rates is mostly felt on credit card, which we are, in our guidance, still calling for credit card to shrink slightly, healthy purchase activity, but there’s a lot of cash out in the environment, as you point out. Some of the prepay rates that we’re seeing on other products are not necessarily stimulus-driven like mortgage with a lot of churn and refinancing where we’re originating taking share. But the portfolio is growing, but there is a lot of underlying prepay risks. But that will start to slow as interest rates go up moderately although we still think volume and demand is going to be very, very heavy that it’s going to turn towards purchase versus refi. So we should see a natural slowing of prepay on the mortgage portfolio.

I’d also say on home equity, we don’t talk about that very often, it’s a very big business for us and it’s been slowly shrinking and shrinking faster in the industry. You’ve got a lot of the big banks that are sitting on the sidelines at the moment that have really curtailed or even shut down their home equity originations platforms. So we’re enjoying market share. That’s almost double what we naturally get which we naturally get really high market share in this industry.

So I expect us to, at a minimum, be a slower decline than others on home equity for prepay speeds given the size and pace of our originations capacity and there is some optimism potentially that we could start to see home equity flatten and not be a headwind anymore for us. So there’s a lot of dynamics, I think, at play there. But really your question around stimulus would be most felt in credit card and that is called for in our underlying guidance and more than offset by those other dynamics.

Bill Carcache — Wolfe Research — Analyst

Understood. That’s very helpful. Thank you for taking my questions.

Bruce Van Saun — Chairman and Chief Executive Officer

Sure.

Operator

We’ll go next to the line of Saul Martinez with UBS. Go ahead please. Mr. Martinez, your line is open. Go ahead.

Saul Martinez — UBS — Analyst

Sorry about that. I was on mute. Hey. Thanks for taking my question. You indicated that most of the expected decline in non-interest income is coming from lower mortgage banking fees, but that it should sort of hit a floor in the second quarter. I guess I just want to understand the logic there a little bit better. What gives you confidence that we will see a floor and we’ll start to see in 2Q and we won’t see further compression in margins beyond that that pressures the overall fee line?

And then secondly, I’ll just ask my second question now. On the swaps, what receive rate are you getting on those because I guess I understand the logic of averaging in and legging into it. But maybe I guess the flip side of that, it does seem a little bit out of step on the surface to me with the view that you expect rates to continue to rise. Whether it seems like maybe you can argue that it’s a bit premature to leg into it already. So you could just flesh that out for us a little bit?

Bruce Van Saun — Chairman and Chief Executive Officer

Sure. On mortgage what we’ve seen happen kind of starting in late third quarter, into fourth quarter, was the industry gearing up in terms of capacity, adding capacity to really capture the whole refi opportunity and that — and then you had some of these big non-bank players going public and being pretty aggressive around market share. So the very high gain on sale margins that were kind of frankly amazing and unsustainable back in Q3 has started to normalize back to historical levels based on those factors, those forces. And so we kind of see that playing out through the second quarter and then restoring — getting restored to levels that we’ve seen historically and the current view is unlikely to go meaningfully below that. So that’s the assumption that we’re making.

The flip side to that is that there is also a strong outlook for originations. We’re looking at over $3 trillion which should be, next to 2020, another record year in terms of originations. And we’re probably seeing a shift from refi to a little bit more purchase in the mix and we’re very well positioned in our retail channel to capture that. So still looking at strong level of originations. So there’s really no headwinds there at all.

And then the size of our servicing book and the MSR asset, all of that should offer somewhat of an offset to the fall in margins. So, we’ll see. I think we’ve been pretty good at forecasting these dynamics. But the market is the market. We’ll see how it plays out. But I think we’ve thought pretty hard about the factors and tried g to project those out. And so we feel pretty confident that that’s the likely scenario for Q2 and then for the rest of the year. So I’ll stop there unless you want to add anything, Brendan.

Brendan Coughlin — Head of Consumer Banking

I think it’s well said. The one maybe data point I would add to that, just to kind of accentuate the rebound in purchase offsetting some of the refi decline is that over the last 45 days we’ve seen about a 30% growth rate in purchase volume coming through our retail channel. So it’s not just hopes and dreams. We’re seeing an actual and real momentum for the business. So we feel pretty good about the volume outlook, to Bruce’s point, the margin is bottoming at 2019 levels is really the key assumption that it doesn’t go any deeper than historical levels and we’re seeing it starting to stabilize right now. So —

Bruce Van Saun — Chairman and Chief Executive Officer

Yeah, good. So we’ll flip the second question over to John.

John F. Woods — Vice Chairman and Chief Financial Officer

Yeah. Thanks. So, Saul, I think the point here is we saw a pretty rapid rise in the five-year over the last several months. As I mentioned, I think at the end of last year it was around 40 basis points. It had gotten, I think, frankly north of 90 basis points. But I think it’s settling in around 80 basis points right now. That is really emblematic of the first sort of risk triggers that we think about. Basically this is an interest rate risk hedging program and that hedging program really requires us to consider where our asset sensitivity is and what the downside exposures are. And so from that perspective, we have several sort of triggers and tranches of hedging that we will do over time. This is the first one. And I think there would be another one as and if rates continue to rise.

Although it’s our expectation that rates will continue to rise, the last sort of couple of weeks, it’s a reminder that things can deviate from your base case. And so we’re just being prudent risk managers and taking our asset sensitivity from around 11% to something that’s in the very high single digits. And as we get to the top of the rate cycle we will get back down to something that’s in the lower single digit similar to where we’ve been in the past. And that’s a very prudent sort of approach versus waiting around for the perfect time to begin to hedge.

The other question you asked was what the receive rate was. During that range of 40 basis points to 80 basis points and the five-year, most of that hedging towards the upper end of that range. But — that will give you the answer there.

Saul Martinez — UBS — Analyst

Yeah.

Bruce Van Saun — Chairman and Chief Executive Officer

Good. All right.

Saul Martinez — UBS — Analyst

Thank you.

Bruce Van Saun — Chairman and Chief Executive Officer

I think there is no more questions in the queue. So, again, I want to thank everybody for dialing in today. We certainly appreciate your interest and support. Have a great day and everybody stay well. Thank you.

Operator

[Operator Closing Remarks]