Citizens Financial Group Inc (CFG) 2015 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Citizen Financial Group's third-quarter 2015 earnings conference call. My name is Brad and I'll be your operator for today's one hour call.

(Operator Instructions)

As a reminder, this event is being recorded. Now I will turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.

Thanks, Brad. Good morning, everyone. Thanks so much for taking time to join us this morning. We are going to kick things off with our Chairman and CEO, Bruce Van Saun. Eric Aboaf will also be reviewing our first-quarter (sic --"third quarter") results and then we will open the call for questions. In the room today with us are also Brad Conner, Head of our Consumer Bank, and Don McCree, Head of our Commercial Bank. I would like to remind everyone that in addition to today's press release, we've also provided a presentation and financial supplement, and these materials are available at investor.citizensbank.com.

I need to remind you that during the call, we make a forward-looking statements that are subject to risks and uncertainties. Factors that may cause our actual results to differ materially from expectations are detailed in our SEC filings, including the Form 8-K we filed today containing our earnings release and quarterly supplement. Additionally, any information about any non-GAAP financial measures, including a reconciliation of those measures to GAAP, may be found in our SEC filings, in the earnings release, and in the quarterly supplement that are available on our website.

And with that, I'll hand it over to Bruce.

Thanks, Ellen, and good morning. It's a pleasure to have the chance to review our earnings with us today. In addition to being joined by Eric, Brad, and Ellen on the call, as usual, I would like to extend a warm welcome to Don McCree, who is now heading our commercial business. I would also like to publicly thank Steve Woods and Bob Rubino for the terrific job that they did in leading the commercial business on an interim basis.

Let me offer a few comments on the quarter before I hand it over to Eric to take you through some of the financial details. We're very pleased with our continued ability to drive positive operating leverage in a challenging environment. We're executing well on our strategic initiatives. We're delivering good loan and deposit growth while investing in our fee-based businesses.

We continue to find efficiencies in our cost base that allow us to self fund investments that we are making growth, in technology, and in risk and compliance. Positive operating leverage was 4% revenue growth over 1% expense growth for 3% on a year-over-year basis. It was 1% over zero expense growth for 1% on a sequential quarter basis. This is driving our efficiency ratio and our profitability improvement.

We also are pleased with the efforts to arrest the NIM decline, quote unquote, as we grew our NIM by 4 basis points in Q3. We're focused on boosting asset yield through mix, risk appetite, and pricing adjustments, and on halting the growth in the cost of our deposit growth. Eric has been very intensely focused on this with our business heads and we're making good traction on that front.

A few other items to note. First off, our top two initiatives are on track. Second, our asset sensitivity continues to be stable with the second quarter. As we know, the Fed will eventually move rates, and in the meantime, we have profitability levers to pull. Thirdly, our balance sheet metrics all remain strong across capital, liquidity, funding, and credit.

A real highlight for us in the quarter is that we continue to attract great talent into leadership positions at the Company. Besides Don, we've brought in new heads of wealth, mortgage, and retail distribution over the past several weeks and we've added a distinguished Fed alumnus to our Board. This is an important byproduct of our separation from RBS and our journey to independence.

With that, let me turn it over to Eric.

Thank you, Bruce, and good morning, everyone. Overall, I feel good about the progress we're making in delivering our growth and efficiency initiatives. We are actively managing the balance sheet to deliver attractively priced loan and deposit growth, and we continue to demonstrate strong expense discipline in the face of a strong industry landscape.

In my comments today, I'll refer to our third-quarter earnings presentation, which you can find at citizensbank.com. Let's start on page 3, with our third-quarter financials.

On a reported basis, we generated GAAP net income of $220 million, which was up $30 million, or 16%, from the second quarter, and up $31 million, or 16%, from the third quarter 2014. Diluted earnings per share were $0.40, up $0.05 from the second quarter and up $0.06 from third quarter 2014. Linked-quarter results reflect revenue growth and lower non-interest expense, driven by a $40 million decrease in restructuring charges and special items. We also recorded $7 million in preferred dividends this quarter, associated with our $250 million March issuance. Those dividends are accrued on a semi-annual basis, so we won't record a dividend again until the first quarter.

In the second quarter, we recorded the final restructuring charges and special items associated with our efficiency initiatives, separation from RBS, and Chicago divestiture. Page 4 outlines these items. For the remainder of the slides, I'll cover our reported results in this quarter compared with prior-period adjusted results to highlight our core trend.

Turning to page 5, we posted solid operating results with net income of $220 million and EPS of $0.40. Net income increased $5 million, or 2% linked quarter, as the benefit of revenue growth and lower expense was partially offset by a higher tax rate. Relative to the year-ago quarter, net income was up 9% and EPS was up 11%, reflecting 4% revenue growth and relatively stable expenses. These results are a nice clean quarter, with little in the way of noise, no restructuring charges, and no unusual items.

We had a slight uptick in other income, offset by a slightly higher tax rate, but the P&L reflects our fundamentals. We continue to generate positive operating leverage on both a linked quarter and year-over-year basis. We grew revenue by 1% linked quarter on good growth and net interest income. On a year-over-year basis, we grew revenue 4% with traction in both net interest and non-interest income as we made progress on our growth initiatives.

We continue to focus on managing costs, and this quarter, we held expenses flat as we build efficiency improvement, while also reinvesting in the business. We continue to make measurable underlying progress against our goals of enhancing our efficiency. These efforts resulted in a 66% efficiency ratio in the quarter, down nearly 1 point from the second quarter and 2 points lower than prior year.

Credit costs also remained credit relatively stable on both a linked quarter and year-over-year basis. Our return on tangible common equity remained relatively stable at 6.6%, up slightly over last year, as we paid our first semi-annual preferred dividend and had a slightly higher tax rate. Our tangible book value per share grew 2% to $24.52.

On slide 6, let's take a closer look at net interest income, which grew $16 million, or 2% linked quarter, driven by good loan growth, an additional day in the quarter, and a 4-basis point increase from the net interest margin. Compared to the third quarter of 2014, net interest income grew $36 million, or 4% over the prior year, driven by an 8% increase in loan growth, partially offset by a slight decrease in the net interest margin due to continued pressure from the low rat environment.

Over the past 12 months, we grew earning assets by 5%, or $5.8 billion, reflecting good momentum in both commercial and consumer, as we continue to deleverage our enhanced lending platform, technology, product set, and strong capital position to serve our clients. As you know, on page 7, we are really keenly focused on defending the margin in this extended low rate environment. In this quarter, we took additional steps to further enhance the efficiency of our balance sheet. We reduced the size of our cash and short-term investment portfolio, along with the associated collateralized borrowing that funded this position. This was worth 3 basis points.

We also have been focused on fine-tuning the mix of our loan portfolio and ensuring that we are gathering deposits in a more cost-effective manner. Consumer loan yields were up as we continued to grow attractive opportunities in student and auto. Underlying commercial yields picked up slightly. We remain highly focused on driving originations and select products that exhibit wider margins and stronger returns such as middle market and industry verticals. We did see slightly higher deposit costs, given the impact of some second-quarter promotional pricing.

That said, we are encouraged that we been able to slow the uptick in cost through a better product mix, target marketing, and sharper pricing discipline. We are continuing to maintain our asset sensitivity. We are at 7.1%, assuming a 200-basis point gradual rise in rates off the 12-month forward curve compared with last quarter at approximately 7.2%. This sensitivity is concentrated at the short end of the curve and the first 50- basis point move would generate significant benefit over a flat rate scenario.

On Slide 8, non-interest income decreased $7 million linked quarter, as we saw good results in both capital markets and mortgage banking. In third quarter, we experienced an MSR valuation swing of $8 million and capital market fees declined in line with the overall market trends. These declines were partially offset by growth in other income and service charges and fees, while card fees, trust and investment sales, and FX fees were all stable linked quarter.

The growth in other income included the impact of an $8 million gain that we recorded on the sale of two branch properties. The remainder of the growth in other merely reflects what normal puts and takes across the number of lines in this category. We also saw a $7 million decrease in securities gains this quarter compared to last quarter. On a year-over-year basis, non-interest income increased $12 million as the benefit of higher other income, card, and trust and investment service fees was offset by decreases in mortgage banking fees, FX, and capital market fees.

Moving on to non-interest expense on slide 9, given the prolonged low rate environment, it is particularly important that we do a good job on expenses. We remain committed to our goal of generating strong operating leverage by actively managing our expense base, while continuing to invest across the Franchise to both enhance our products and distribution capabilities. Third-quarter expenses came in at $798 million, down slightly compared to the second quarter, reflecting lower costs across several categories.

Year-over-year adjusted expense increased $9 million, or 1%, as lower salaries and benefits and amortization of software was more than offset by an increase in other expense, depreciation, and outside services. Headcount decreased modestly during the quarter and remained relatively flat compared to the third quarter 2014, even though we added roughly 430 salespeople across our consumer and commercial growth initiatives.

As I mentioned earlier, we achieved an adjusted efficiency ratio of 66%, which was down nearly 1 point from the second quarter and down 4 points from the prior-year quarter, given the benefit a positive operating leverage. We continue to stay focused on delivering our growth and efficiency initiatives, including the top two programs to continue this favorable trend. While it's in its early days, top two is on track.

Turning to the consolidated average balance sheet on slide 10, because of the balance sheet repositioning that I mentioned earlier, our total earning assets of $123 billion were relatively stable with last quarter, as growth in commercial and retail loans was offset by a decrease in short-term investments. Consumer loan growth reflected continued momentum in student, mortgage, and auto loans, which was partially offset by a continued decline in home equity balances and the rundown of the non-core portfolio.

Commercial growth was driven by commercial real estate, franchise finance, and corporate finance. As I mentioned, we continue to refine our strategies to grow deposits any more cost-effective way, and here we also continue to gain traction. Average deposits in the third quarter increased $2.5 billion, or 2%, over the second quarter, and were up $9.3 billion, or 10%, over the third quarter 2014.

On Slide 11, consumer banking loans increased $863 million, or 2%, sequentially, driven by growth in student, mortgage, and auto. Consumer loan yields increased 1 basis point, reflecting continued improvement in mix, as we focus on attractive opportunities in student and our own auto origination.

On Slide 12, commercial loans increased $524 million, or 1%, linked quarter, driven by growth in commercial real estate, franchise finance, and corporate finance. We're being thoughtful about how we claim commercial, given strong competition, and our effort to improve risk adjusted returns and yields, and our results also reflects some normal seasonality.

Slide 13 focuses on the liability side of the balance sheet and our funding costs. Average interest-bearing deposits grew $2.1 billion, or 3%, linked quarter, with particular strength in money market. We were also making progress in growing DDA accounts.

While our deposit costs crept up again this quarter, the pace of growth slowed, as we began refining our retail promotional rate offerings to be more targeted than in the first few quarters following last year's Chicago divestiture. We also carefully we calibrated some above-market commercial deposit pricing. Compared to a year ago, average interest-bearing deposits increased $8.4 billion, or 13%.

On slide 14, we've laid out the key initiatives that support the balance sheet and fee growth in our turnaround plan, as well as our incremental top two initiatives and assessed progress during the quarter. We are continuing to lay strong foundations and gain momentum across most of these initiatives and our intensely addressing some of the challenges in mortgage and wealth. In asset finance, we need to shift our origination strategy, given RBS's retrenchment in the US, as they had been an important source of flow.

On Slide 15, I will highlights on credit quality, which remained benign, with net charge-offs at $75 million and provision of $76 million. Asset quality remains very, very good. Our NPLs were down $16 million, or 2%, in aggregate in the quarter. Our allowance to loans remain relatively stable at 123 basis points, while our allowance to NPL ratio improved from 114% to 116%. We do not see any meaningful issues in our relatively modest-sized energy portfolio.

Turning to slide 16, our capital position remains robust. This quarter's CET 1 ratio was 11.8%, which was well above our peers. We're above our LCR requirement and our LDR has been relatively consistent. In August, we executed a $250 million subordinated debt issuance and repurchased shares from RBS, which on a pro-forma basis, impacted our CET 1 ratio by 22 basis points, but had no impact on our total capital ratio.

Turning to slide 17, let me summarize some of what you can expect next quarter, but all in the context of the full-year 2015 outlook that we've previously provided and that we broadly reaffirm today. Compared to the third quarter of 2015, we expect to produce linked quarter loan growth of roughly 1.5%, broadly consistent with recent quarterly level. We also expect net interest margin to remain stable with Q3.

We will continue to focus on improving asset yields and better managing the cost of deposits. We expect modest expense growth in Q4 due to technology projects coming on the stream, as well as seasonal factors. We would expect to continue to generate positive operating leverage, thereby improving our efficiency ratio, profitability, and returns.

We expect underlying credit metrics to remain strong and favorable, but we would expect the provision to build in Q4. Finally, we expect that our CET 1 ratio will remain relatively unchanged from the Q3 11.8% and we will manage the LDR to around 97% to 98%.

With that, let me turn it back over to Bruce.

Thanks, Eric, and in summary, we feel pleased with our performance this quarter. We have a good plan and we are executing well against that plan. So with that, why don't, Brad, we open up the line and take some Q&A?

(Operator Instructions)

We'll go to the line of Matt O'Connor with Deutsche Bank. Please go ahead.

Could you just talk about the approach to managing the balance sheet going forward with rates seemingly staying lower for longer? And even if we do get an increase, maybe it's just 1[%] or 2[%]. You guys are obviously very asset-sensitive. How do you think about maintaining that asset sensitivity versus maybe bringing it down a little bit to protect the NIM going forward?

Why don't I start? Eric, you can add to it. We've consciously maintained relatively stable asset sensitivity. We do think the Fed will move, and I'd like to refer to our position as a coiled spring that will release and deliver some meaningful net interest income benefit.

At this point, late in the zero cycle, zero phase, to go increase our asset duration meaningfully would potentially snatch the feat from the jaws of victory. So we will take some steps at the margin to recognize that the horizon is being pushed out and it's likely to be more gradual than initially we anticipated, the market anticipated, but I don't think we should change the position in a substantial way. Eric?

Matt, I'd add the following. Our asset sensitivity is highly concentrated at the front end. 80% of it literally comes through in year one, from 6% front-end in year two. So the opportunity cost isn't particularly large. To close down our position, it's not as if we put on a five- or 10-year duration positions. We literally have to put on one and two year swaps, and if you think about what you can earn on that, it's actually quite small.

And so the payback, even based on current forward curves, and clearly they swing around, it's 3 to 4 times. So you're really in a position where we feel like there's some decent upside, even with these lower forecasted and slower forecasted rate increases once perhaps every six months. That's a better position. That's a position that we'd prefer to hold for the time being.

Then just separate from the rate discussion, as we think about the balance sheet optimization that you made some good progress on this quarter, and obviously that helping the NIM, how much more of that is there to do from here? It's obviously good if you can grow net increased income and keep the balance sheet stable, but how much more opportunity is there to, call it, re-mix, or as you mentioned, tweak some deposit pricing? How much more and how much does that play out in the NIM over time?

What we have is we have an opportunity to continue to defend NIM with rates in a relatively flat scenario here. We've been -- for example, in the deposit side, we've been inching up our deposit costs about 2 basis points per quarter over the last three, four quarters. We've been able to slow that down to 1 basis point and you can imagine, we're trying to slow it down even further. With Don and Brad's support, we found some good opportunities on the deposit side to do that.

On loans, the work continues. It's primarily product mix in consumer, it's tactical pricing and returns and some mix in commercial, a mix of product mix there in commercial and pricing acumen and intensity. That in a way helps us defend the back book roll off which continues.

So in a flat rate environment, we have an ability to keep NIM stable. We will try to tick it up a little bit, but we've got it stable, and for the time being, until we see some real rate rises, we have some confidence in being able to continue to deliver that.

Okay. Thank you very much.

Our next question will come from Ken Zerbe with Morgan Stanley. Please go ahead.

First of all, I thought it was great that you guys were able to keep expenses down, given the further investment in the business. Could you just give us an update, though, on where you stand with top two going forward, or at this point?

In top two, as you recall, Ken, there were three major categories. One was expenses, one was pricing initiatives, and then one was the broader revenue initiatives. On the expense side, we're making excellent progress around the main two thrusts there. One is what we call ops transformation, where we are stepping back and taking a look at how we're organized and making some changes, and, ultimately we're aiming for the hat trick, we like to call it.

We want to have a better customer experience, better [risk it] controls, and of course efficiencies, and we're starting to see some of those efficiencies come through. They'll come through additionally in Q4 and have a full-year effect on 2016. We also have a greater effort to work through vendor contracts, and looking for opportunities to consolidate and get better pricing from vendors.

That has been part of top two and that is also flowing through as we work through that initiative. So we feel quite confident that we've already got that in motion. We are starting to see some of the benefits come through and it is on track. Pricing, similarly, a bunch of that is on the commercial side, cash management is one area.

We're rolling that out in waves and so you're going to start to see that flow through here in the second half of the year. Then will get a full-year effect of that in 2016, so we see that tracking to expectations in terms of client impacts and our ability to execute that program.

On the third bucket of revenues, we have a couple of major thrusts there, which are in pilot phase. That's largely on the consumer side; there's a little bit on the commercial side there, as well. So we've been running the pilot through Q3, we've expanded the pilots into Q4, and we're putting the infrastructure in place to do the full rollout early in 2016.

Everything we've seen in those pilots is positive in terms of our ability to deliver the revenue potential on the full program. So, broadly speaking, I'd say, we feel good about the program taken as a whole.

All right. That's great. Then just really quickly, on the iPhone financing, I know it's a small piece of your business, but any commentary on how that financing program has been going?

I'll start. Brad, you can obviously put more depth and color to it, but I'd say we were very pleased. First off, that we were able to secure the partnership with such an iconic company like Apple, and they certainly have high expectations for their partners in terms of delivering an outstanding customer experience.

What we're most pleased about is we've certainly executed the program extremely well and have really satisfied Apple as a worthy partner and the customers are getting good experiences as they come in on to this program.

It is ramping about to expectations, so it's a relatively modest pilot in the stores at this point. It will move later to online, which will ramp it up to greater size, and then obviously, you get into the whole Christmas season, and through Thanksgiving to Christmas is a sprint. So we do expected to see a fairly good level of ramping up in Q4, but we're very pleased with what has occurred to this point. Brad?

Bruce, you did a very good job of covering it. [Also] it started very much in line with what we expected. It was nominal impact on the quarter, about $60 million in balances for the quarter, so it was a nominal impact on the quarter, but it is giving us confidence that it's a very viable program for us in the long run.

You said it well, we're pleased and Apple is pleased and the partnership is off to a very good start so there's strong potential for the program for the long run.

Great. All right. Thank you very much.

Our next will come from Erika Najarian with Bank of America. Please go ahead.

My first question is on the efficiency ratio. You clearly have made good progress year-over-year from 68% to 66%, and given that, like Matt said, investors are much more of the mindset of lower for longer, could you take us through how much more improvement that could be in 2016 in this efficiency ratio if rates don't normalize?

The key to that is really just to stay focused on delivering positive operating leverage. Regardless of what happens to rates, we have a good capital position and an ability to grow loans, and if we do a good job on NIM, that will flow straight through and create a good continuing source of revenue momentum. We're investing in our fee-based businesses.

Some of the people that we put in place have to season and that should help our fee projections going forward, and we are going to continue to hire and continue to build those business, but we will be making a spread over who we put in place and what it costs us to put those people in place. So that should be contributive to positive operating leverage.

Then on the expense side, we've worked very hard to try to self-fund the investments we need to grow. So that means a continued effort to look at the zero base of expenses and go in and find places where we might be inefficient and pull -- extracted those expenses so that we can try to keep overall expenses as close to flat as possible.

We were able to achieve that to quarters in a row, which is really quite something when you consider the amount we are putting into technology and the amount were putting into playing offense in our growth initiatives and some of the demands on us from an overall risk and control and regulatory standpoint. So we think it ultimately gets a little harder. We've called out in Q4 that we'll see a little bit of growth in expenses.

Some of the technology depreciation and software amortization is going to come on stream in Q4, but we're committed to really staying 100% focused on delivering the positive operating leverage because that ultimately drives the improvement in the efficiency ratio and it drives the improvement in our profitability and our ROTCE. So as we go through our budget process into next year, every member of the Management team has a real focus on that.

Got it. Just a follow-up question for Eric. Given that you're compliant with the LCR, should we think about the size of the securities portfolio from here relative to your loan and deposit growth?

The securities portfolio is right-sized to be honest. We run an LCR above the requirements but not way above purposefully. So we got a good-sized balance sheet. You saw that we compressed it a bit this past quarter as we took out some collateralized borrowings that we didn't think were particularly valuable to have and in the LCR world you don't get credit for.

That had a small reduction effect on the portfolio, but the portfolio is properly sized. Over time, you'll see that we will use a mix of MBS and treasuries from that portfolio and then classic vanilla interest rate swaps to manage the duration. So it's within the range, probably go up and down a bit here and there, but within the range for now.

Okay. Thank you so much for taking my question.

Our next question will come from Vivek Juneja with JPMorgan. Please go ahead.

A couple of questions. Can you update us on your plans on loan portfolio acquisitions, since that was something that you all had done more actively last year and even earlier this year? Third quarter, it doesn't seem like you had anything material, but if you could just update us on that?

I'd say we always viewed those portfolio acquisitions as a bridge to building out our own capabilities. The SCUSA arrangement was put in place before we had really rolled out our broader platform and our ability to really penetrate the prime sector of the market. As we have been able to scale our own capabilities up, we've been scaling back on that SCUSA flow agreement.

We also opportunistically entered into an arrangement with SoFi on the student loan side. We like the overall marketplace and the product that they originate has characteristics of very high credit quality and good risk-adjusted returns like our own growth and so that allows us to accelerate our growth a little bit. That is a modest sized program. It's about $500 million over the course of the year.

Other than that, at this point, we don't have much going on or much that we are looking at, but we will continue to be opportunistic. As I said, we have a very good capital position and we're putting that capital to work through our own channels and building client relationships and building our book of relationships and customers that we can cross-sell into. But again, if there are opportunities that come up, we will take a look. Brad, why don't I ask you for--?

Yes. You did a great job. I was just going to add one point to this, which is we did step the SCUSA portfolio purchases down from second quarter to third quarter and you can expect -- we expect one more step down in the fourth quarter. So it will actually be a little bit smaller still in the fourth quarter, so we're continuing to step that down.

Okay. And on the resi mortgage side?

When you look at the maps on the quarter, probably around 10% of the net loan growth was the net purchase volume, so it's quite a modest number, at this point.

Okay, good. That means even resi mortgage, you are doing through your own originations now, more and more?

More and more, right.

Yes. Okay. Brad, a question for you on mortgage. Can you give a little more color on what happened with mortgage banking? It seems like you had an MSR hedge loss? And how you're tracking on originations with all the hiring of the mortgage officers? I know you've had a change in Management you just announced a couple of days ago. So you can give us some more color on that?

It hit in a couple of buckets. You mentioned the MSR change. We have a $6 million recapture on our MSR asset in second quarter. We had a $1.7 million impairment this quarter.

So when you look at the mortgage fees, we had about an $8 million swing from quarter to quarter, so that was an impact and a step down on mortgage revenue. We actually saw our application volume drop about 10% in the third quarter. Much of that was just market-based, that's pretty much consistent with the market.

I would say, in terms of our hiring, if you look at our hiring, year-on-year, we are still progressing well. It was relatively flat quarter for net hiring in the third quarter. Some of that is extreme competition in the marketplace so we're seeing a lot of competition for good quality loan officers. We're attracting loan officers, but there is a little bit of a hand-to-hand combat happening out in the marketplace.

Then the other thing that impacted that was -- and of course, the whole industry dealt with this -- was a little bit of distraction with the [total resting] implementation, the trade implementation, which happened in early October. It really did put a lot of strain on operations capacity for us and the industry, so we actually ended up from a loan officer hiring perspective, we were up net one in the third quarter.

And the good news underlying is that we continue to increase our market share.

Right.

So as we are going to loan officers, our market share for each of the last three quarters has continued to [pick up]. The originations in the quarter were up on a sequential quarter basis, so notwithstanding that [apps] were down a little bit. The actual originations that came through were up.

On the Management change, we had a couple of our folks looking to retire at the end of the year who have been good soldiers for us, both on the wealth side and in mortgage. And we're fortunate that we are able to go out into the market and attract some real talent into the Organization.

Okay, great. Thank you.

Our next question will come from the line of Geoffrey Elliott with Autonomous Research. Please go ahead.

On the final exit of RBS from your shareholder structure, whenever that happens, could you talk about what impact that's going to have on your operation [lead], either in terms of where you get more flexibility or where potentially there is a bit of dissynergy in that they have been helping you get some business?

Frankly, at this point, there won't be much impact at all. Most of the overall impacts of them stepping down their ownership and shrinking their business activities across the globe and here in the US have largely played themselves out. We did call out the asset finance area was one place where we were getting referrals from their overall credits book and their relationships, which we need to figure out, though, that will over time decay and erode and we have to figure out how we're going to replace that.

We have some ideas on that, but we did color code that initiative to grow that business amber at the moment until we've sorted out, something that Don is very focused on. But more broadly, we also, in capital markets, have used their platform and jointly called in some areas and we had plans to ultimately migrate off their, for example, FX and derivatives platform, and go on to our own platform in Q1, which will actually increase our flexibility in terms of the products we offer and some of their versatility we will have in being able to face off against the market. So that's a little bit of upside actually that's coming.

Then with respect to RBS' overall risk oversight responsibility as a source of strength for Citizens, we've had generally good agreement and support from them as we've moved from playing defense to offense about any changes that we've looked to make in our risk appetite.

So I don't think there'd be any big change in terms of them stepping back from having those oversight responsibilities. I would say, largely, most of the impacts are baked into current results or our current forecasts.

Thanks. Then, switching topics, a little bit, the step-up in commercial yields this quarter, what was behind that? Was it mix or was it pricing improving?

Eric, why don't you take that and then flip it to Don for color?

The core of that is some pricing discipline. We saw origination yields across commercial tick up almost 20 basis points. There tends to be volatility from quarter to quarter, but that was a larger than typical uptick, and if you dig deep, what we've been doing is working very tactically with our bankers and helping them with benchmark data on pricing so that they can price effectively on new business.

That's been quite productive, as well as about three months ago, four months ago, it would have been in the middle of the second quarter, we rolled out our updated returns calculator, which also gives them some real insight and tools. So we've been helping there and that has begun to get some nice traction and we are starting to see the results of that. Obviously, there will be some volatility from quarter to quarter, but we're pleased with some of those early results.

Eric, that's exactly right and I feel that, that's fully embedded in the commercial bank division right now. I'd point to the fact that we are doing less low-margin business, which is moving the overall book slightly up, and as Eric said, it will move a little bit quarter to quarter, but we feel like the discipline is fully embedded.

Excellent. Thank you.

Our next question will come from Ken Usdin with Jefferies. Please go ahead.

My first question is just on the fee outlook. It's the one path that you guys don't talk about in the explicit guidance. Eric, I heard your point about some of the third-quarter items were certainly in line with market behavior. Can you just give us an update on your outlook for fee growth trajectory and any changes versus prior expectations, if any?

I would just say, Ken, we did have a clause in our outlook statement about fees, at the time where we said we anticipate fee income growth. Typically, that is not part of the outlook, but anyway I would say in general the fourth quarter has some seasonality to it. So when we look at some of the activities on the consumer side, we typically see a nice little seasonal updraft there.

We had, on the commercial side a relatively quiet third quarter and there's often seasonality there, as well. We typically engineer a few [leasing] transactions in the fourth quarter, so there is some optimism around our ability to move the [chains] both on the consumer side, as well as on the commercial side. Eric, you want to add to that?

No, that covers it well.

Thank you, Bruce. Stand corrected. I see it on the deck. Second question, on CCAR, when you got your original approvals for the three years, it included the $250 million for next year. I know we haven't even gotten scenarios yet for next year, but my question is just do you think you'll even be able to contemplate a different ask than that original $250 million or are we really talking about 2017 CCAR for a different CCAR ask than that original $250 million you got for 2016?

I should explain that a little bit, Ken. But that $250 million effectively was the tail of a multi-year agreement that we had worked out with the Fed around our desire to put a capital stack back in place that mirrored our peers. So ultimately, it was to $2.75 billion of buyback with a linked issuance of capital securities.

We have just simply run that out and we put that last remaining $250 million out into the next CCAR submission. That really is not an indication of what we think we'll do in the next CCAR submission. We have to go through our -- all sources and uses of capital and how fast do we think the balance sheet is going to grow and what do we want our dividend policy to be.

So we will -- and then where do we want to land in terms of continuing to chip away at the high level of capital that we have -- CET 1 capital relative to peers. So, we'll dialogue with the Fed about that and we'll go through the process and we'll make some determinations, but clearly, I don't think you should take away that, that $250 million is locked in stone.

Okay. Then just one quick clarification then on that $250 million, was that $250 million just a year thing, meaning that was that $250 million, in fact, could that still even happen in the first half and not even be part of the 2016 program or is it distinctly part of the second half and beyond 2016 program, whether you ask for more or not?

I'm not sure I completely follow, but I'll just try to explain. In the four-quarter CCAR submission that we just had approval for, we've had two $250 million transactions, which we've already executed. This $250 million was indicated to be in the next submission and early in the period for the next submission. We will certainly look to do that and then potentially something additional as we work through the plan for the next submission.

Understood. Perfect. Thank you, Bruce.

Our next question in line will come from Matt Burnell with Wells Fargo Securities. Please go ahead.

My first question really relates to what looked like pretty stable balances in the commercial business, the C&I business, specifically, and pretty healthy growth in the commercial real estate portfolio. Could you give us a little more insight as to what the trends are in both those portfolios, and if that's going to be a primary driver of your growth in the fourth quarter?

Yes, Matt, let me start, and then Don will weigh in, as well, to give you a little texture. You saw some average balance growth in C&I. In particular, you saw a little bit of small dip, EOP, on the C&I line. On the other side on the ledger, on the CRE, as you described, you had nice sequential growth of 6%, which was particularly healthy and robust.

There's some movements there. Originations have been, on commercial, and in C&I, in particular, have been pretty decent all year, including this past quarter. A little less activity on draws, which tends to sometimes be seasonal, but it's a business where we continue to see some momentum, on the one hand, and on the other hand, it's intensely price competitive, and we're also being disciplined and careful about where and how we grow that.

Let me just add to that. That's exactly right. It's a tale of many cities. We're seeing really good growth in real estate, we're seeing really good growth in franchise finance, a little bit of weakness in our asset finance business, a little bit of weakness in our midmarket business. The midmarket business is entirely due to utilization.

A suspicion there, although we haven't fully proved out, is much of that has to do with commodity prices and general economic outlook in some of our midmarket areas. We just think our clients are borrowing a little bit less money at this split second, and we also see that in the opposite indicator, which is growth in our deposits.

So we feel very good about where we are in terms of quality of intensity, quality of upgrades, of personnel developing pipelines, quality of calls in terms of corporate finance calls, as opposed to just lending calls. So all of the indicators we see in the franchise are excellent and we think we're setting the stage for continued growth in the business.

So Don, are you getting an elevated level of paydowns in the third quarter versus the second quarter, which we've heard from a couple of the other regional banks?

I haven't seen it necessarily in paydowns. We've seen it in utilization, so less draws under existing commitments. And it more than explains the entire total reduction in C&I loans so we are growing in underlying portfolios, but we are also building our pipelines and we don't see the overall commitment book decline.

Paydowns were actually in line with the average for the last five quarters. Paydowns were actually a little lighter than in the second quarter, for that matter, so just on the utilization line this quarter, which tends to be jumpy. We have utilization, quarter-over-quarter, you see swings in utilization of $300 million, $400 million, $500 million, and so obviously carefully working through it, but not particularly out of the ordinary.

Eric, my second question is for you, in terms of the cost of the long-term debt has come down quite dramatically. The balances have increased a bit over the past year. Is there much more you can do in terms of bringing the cost of your long-term debt down as part of your NIM planning?

Long-term debt is, like you say, it's long-term, right? There's a limit to what one can really do. We have tended to issue floating or issue swap to floating, which gives us some flexibility, and obviously, we'll manage that in the scheme of our duration position.

From a perspective that we have is that over time, we have said that we'd add a little bit of senior debt to the stack just to be a little more balanced. That said, we'll do that carefully and modestly, given the rate environment. But if there are some low points in the curve, it's also a nice time to pull a little bit of that down, put it on the balance sheet, and do it at a time before the rates pop-up.

Thanks for taking my questions.

Our next question will come from Gerard Cassidy with RBC. Please go ahead.

Can you share with us your thoughts about capital. You've touched on it already, but you guys obviously have capital levels, your common equity Tier 1 ratio is above the peers, as you pointed out. What's your comfort level in where you think that could get to and what strategies would you use to -- I'm assuming bring it down?

Well, what we've done up to now, Gerard, is a combination of actually the conversion transactions, which in effect buybacks. We've had dividend policy set at 25% to 30% and we had an ability and a desire to really grow loans and grow the loan book and growth to that strong capital position.

I do think it is a bit of a loop here, as we put that excess capital to work, it helps drive revenues. It helps drive that positive operating leverage and it helps improve our returns. Then the more capital we can self-generate, then we can feel confident that we can meet all the requirements to run the business without having to have that cushion.

So the calibration in terms of the timing for removing some of that surplus really is linked to some degree to how quickly we can get our returns up so that we're self-sufficient and were not hamstrung when we see good opportunities to grow loans. We don't want to be drawing down that capital for position that's [below us], so that to me is the timing.

It will be a combination, going forward, of probably faster than peer loan growth. Ultimately, when we're in a sustainable position to be able to do that, then we can look to increase the buybacks and bring that capital level back to where peers are. There's no reason, at the end of the day, once we're through our turnaround period, that we should have a new guy premium, if you will, quote-unquote, and a higher capital level than peers.

There's nothing in the mix of our business, our risk appetite, our stress losses under CCAR, that would say there's a requirement for the medium-term or longer-term, to hold extra capital than peers. I do think we are just managing our way through this and using it as an advantage right now as we work to improve our overall performance.

Thank you. I agree with you about the new guy premium is not going to be needed. If we get to 2017 -- and I don't think the regulators will allow this in 2016 -- CCAR, but if you all, the industry, not just Citizens, are given the opportunity to give back in excess of your estimated earnings in that CCAR, would you guys consider doing that, where you could really bring it down to get that ROE to a higher level?

I'd fall back on my previous answer. I don't know if I want to be pinned down to timing. We have got a lot of things over 2016 and 2017 that we have to see play out in terms of the path for the Fed and the path for our profitability improvement. So I do think we'll certainly monitor the signals coming from the Fed and where the peer group looks likely to go, and over time, continue to try to narrow that differential.

Great. Then finally, shifting gears, you guys mentioned that you had a deposit program in place with higher rates, which you have started to fade away going into the third quarter. Are there any plans for 2016 for any deposit specials, where you look to grow the deposits through maybe higher rates or special products?

It is Eric, Gerard. We take deposits, quarter-to-quarter, from a tactical basis. What you've seen us do is fade a little bit of some of the more aggressive promotional campaigns we had been doing in consumer, as over the last couple of quarters, and with Brad's help and guidance of the team. Also just being careful about being in line with peers as opposed to ahead, we been able to tamp down on the increases that we've seen.

We have even been doing better month after month after month here, even during third quarter. That's the kind of thing we expect to continue. I said something similar on the commercial side, where we've been repricing some old balances. That will continue. As rates rise, ideally rise next year, prevailing market rate, we will likely do what you'd expect, is typically lag.

We've disclosed our betas. The betas are -- there's much more of a lag in consumer than in commercial typically. What you will find us do is over and above that, there's a product question you asked, specifically is in consumer. We continue to reevaluate the product set to make sure that it's designed to encourage checking account balances, those low interest rate balances, those DDA balances.

On commercial, one of the byproducts of growing the cash management business is it brings in DDA balances. So, that's where the initiatives, on one hand, that we've talked about for multiple quarters ties to some of the funding costs opportunities that we've seen.

Our next question on the line comes from John Pancari with Evercore. Please go ahead.

Just a quick question, back to the margin. It's good to see the pricing and the other yield initiatives that are benefiting the margin, and it sounds like that's sticky, and that the margin could hold at this level. Could you talk about the risk that it could come at the cost of loan growth as you focus on these pricing opportunities and then what that could mean for annual growth for 2016 in the total loan balances?

John, it is Eric. Let me start. The first part of the margin, the yield enhancements that we've seen, in particular, on loans, is around product mix. So as we grow student loans, even the Apple balances, the organic auto, those are actually accretive to our yields, so literally the benefit of growing higher yielding products has a benefit.

There is a similar area in commercial, as in commercial real estate, where we're becoming increasingly disciplined, for example, on our REIT business, and actually expanding other areas instead. So that mix effect is actually a natural way to defend the yields, if not to actually expand them.

The next piece then is actual apples-to-apples pricing on commercial loans. That's where you're in the trenches, and with -- Don and I are conscious that you push a little too much on price and volume can adjust, and what we're trying to do is carefully find what that elasticity is and where the appropriate point to price on so that you get both -- you get good yielding loans and volume. That's what we do daily. Do you want to--?

I'd agree with that, Eric. The important thing is we're really managing this on a client by client, loan by loan basis, with a lot of [senior] intention to it. So we're making smart decisions on where we went to play and where we don't want to play and I don't think our effort to be disciplined on pricing is going to have a particular effect on volume. I feel it's a competitive market out there and we're trying to stay at disciplined as we can, both on the credit side and on the pricing side, but we see lots of opportunity.

Given that, could this 1.5% linked quarter loan growth expectation carry through for 2016 and therefore we're looking at somewhere in the ballpark of 6% annually?

What we've said consistently this year is that we will give you our 2016 guidance in the January call. But what we've proven since we've been a public Company is we can shoot for something like that. We've been able to deliver it, but I really don't want to get drawn in on 2016 until January.

Okay, that's fine. Then one last question is on the ROTCE. As you acknowledged early in the call, it was relatively stable here around 6.6% or 6.7%. Can you just update us on your thoughts around the pace in the improvement in that ratio that you expect, barring any help from the Fed?

Yes, that's similar to your last question. We're very focused on delivering a positive operating leverage. We are, at the moment, building capital because we've made our share repurchases that are authorized under the CCAR, so you have a little bit of a headwind in the denominator.

[But the flip side] of that is you are growing your book value per share, which is also a positive. But what we start to -- we will have everything working for us again in the next CCAR cycle, if we're delivering the profitability growth and we can get the buyback, back into the equation on consistently quarterly basis, then hopefully we [aren't] building capital at the same clip.

Okay. All right. Thanks, Bruce.

Our last question will come from the line of David Eads with UBS. Please go ahead.

Maybe just one last one from me. If you could talk a little bit about the capital markets line. You dipped a little bit from a really strong second quarter. I was just curious how much of that is due to market factors versus seasonality and timing and just the general lumpiness of that business?

I'll take that. I would point to just the volatility in the market in the third quarter. It was across high-grade, high-yield, and the syndicated lending market. It was just tremendously volatile and the market seized up really toward the back end of the summer and that was on top of what we usually see, which is a summer slowdown, in terms of the transactional business.

So, I do think it was a tough comparison with the second quarter, as you said, which was a very strong quarter. We're seeing reasonable activity as we move into the fourth quarter.

Yes, as I indicated in an earlier answer today, that we typically see a seasonal pick-up in the capital markets area in Q4, and it looks like our pipelines would give some confidence to that statement.

All right. Thanks for the color.

Okay. All right. Well, that's all the questions that we have for today. Thank you for dialing in and joining us this morning. Again, we feel we have another good quarter, pleased with our performance, executing well, and feel quite confident about our future outlook. So thank you and have a good day.

That concludes today's conference call. Thanks for your participation. You may now disconnect.