Citizens Financial Group Inc (CFG) 2016 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Citizens Financial Group third-quarter 2016 earnings conference call. My name is Daniel and I will be your operator today.

(Operator Instructions)

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

Thanks so much, Daniel, and good morning, everybody. Thanks for joining us today on the call. We're going to begin things with our Chairman and CEO, Bruce Van Saun, and Eric Aboaf providing a review of our third-quarter results and then we're going to open the call up for questions. We are also really pleased to have Brad Conner, Head of Consumer Banking, and Don McCree, Head of Commercial Banking, with us this morning.

I would like to remind you that you can find our earnings materials on the website at investor.citizensbank.com. There is a presentation there that we're going to walk through.

The lawyers have asked me to also remind you that our comments today will include forward-looking statements that are subject to risks and uncertainties. We provide information about the factors that could cause our results to differ materially from those expectations in our SEC filings, including the 8-K that we filed today.

We also utilize non-GAAP financial measures and provide information about reconciliation of those measures to GAAP in our SEC filings and in the earnings release material.

With that I'm going to hand it over to Bruce.

Good morning, everyone. Thanks for dialing into our call this morning. We've reported some very strong results today as we continue to execute well on our turnaround strategy for Citizens. Eric will take you through all the key numbers and color in a moment but let me call out some of the highlights.

EPS for the quarter was $0.56. That included $0.04 of what we refer to as notable items, the TDR sale gain, partially offset by several charges and writedowns. The underlying adjusted results of $0.52 per share was up 13% linked quarter and 30% year on year. Really terrific.

The good momentum we had in Q2 continued into Q3. The environment broke our way with good capital markets and global markets activity levels, a bump in LIBOR rates, and a lessening drag from the long end of the curve.

Our team is executing very well. We continue to run the Bank better for all of our stakeholders. We remain very focused on delivering a differentiated superior customer experience as the key to our long-term success.

It is nice to see ROTCE reach 8%. We've delivered the controllable part of our original ROTCE walk. It is the lower-for-longer rate environment that has held us back from even better results. But, rest assured, we are not waiting around for rates to rise. We are focused on continuous improvement.

We delivered 450 basis points of positive operating leverage year on year, adjusted basis. And our efficiency ratio has improved by 3% to 63%. We're getting some lift in fees as the investments that we have been patiently making are starting to show some traction.

Capital markets and mortgage in particular had strong quarters. We did a good job on net recruiting. We added 47 mortgage LOs in Q3 and 11 financial consultants in wealth.

It will be important to stay focused and continue to execute well in Q4 and in 2017. We can't expect these types of sequential EPS jumps every quarter but it is pleasing to see the hard work is paying off.

With that, let me turn it over to Eric.

Thanks, Bruce, and good morning, everyone. Our third-quarter results highlight strong progress as we continued to grow our balance sheet, deliver robust positive operating leverage, and smartly manage our capital base. Our key metrics continue to improve nicely -- EPS growth, efficiency ratio, and ROTCE. And this marks the ninth straight quarter that we've delivered positive operating leverage.

Our earnings of $0.56 on a GAAP basis include some notable items that we've detailed on page 4 of the earnings presentation. As previously announced, as part of our focus on optimizing the balance sheet we completed the sale of $310 million of home equity and mortgage loans classified as troubled debt restructuring at a pretax gain of $72 million.

As part of that work that we did in conjunction with the TDR transaction, we conducted a broad technology and operational review related to the home equity business. We ended up writing off some software and adjusting some legacy processes to enhance customer experience and outcome. The cost of these items was $8 million, which resulted in a remaining benefit from the gain of $64 million.

A further balance sheet optimization initiative resulted in charge of $16 million as we completed a deep dive review of our asset finance business and elected to put certain single-product leasing-only client relationships into runoff that were tied to our legacy RBS business model. These relationships don't fit our targeted client profiles and return levels.

In connection with this type of decision, our experience is that clients are less likely to work with us to resolve issues regarding the value of the collateral. And this fact, coupled with the recent decline in several aircraft valuations, resulted in impairment write-downs of $16 million on the residual values on the leases.

And, lastly, we incurred a $17 million expense associated with our top three expense initiatives related to severance and consultants.

With that, let's take a closer look at our third-quarter 2016 earnings presentation, starting with page 5. These GAAP results include notable items in the quarter.

On a GAAP basis we generated net income to common stockholders of $290 million and EPS of $0.56 per share, which was up 19% sequentially and 36% year over year. On page 6 you can see the highlights of our third-quarter adjusted financial results, which exclude the impact of notable items. We believe this view provides the best picture of underlying momentum.

Net income to common of $271 million is up 12% sequentially and 27% year over year. We grew net interest income $22 million or 2% linked quarter, as we continued to deliver solid loan growth and held NIM stable. The NIM performance is better than expected as we saw a better than anticipated lift from LIBOR and continued strong results in shifting portfolio mix.

We also continued to make progress on fee income front, with adjusted noninterest income up 4% sequentially, driven by strength in mortgage banking and service charges and fees. At the same time, we held expenses relatively stable linked quarter despite our continued investments in front-line personnel. And credit continues to be benign as provision expense is down $4 million. So, on a linked-quarter basis adjusted EPS increased $0.06 or 13%.

Compared to adjusted third-quarter 2015 results, net income to common stockholders increased $58 million or 27%, with earnings per share up 30%. We grew NII 10%, reflecting strong loan growth and an 8 basis point improvement to NIM, given higher loan yields and short-term rates. ROTCE was 8.6% in the quarter. And adjusted ROTCE hit 8% for the quarter, up 1.4 percentage points from a year ago.

On pages 7 and 8 you can see the drivers of our NIM performance this quarter. With one-month LIBOR increasing and the continuing mix shift within the retail loan growth to more attractive categories, we picked up 3 basis points on loan yields. However, we gave up 1 basis point of spread in the investment portfolio, and deposit costs increased 2 basis points, largely tied to the commercial book.

Year over year we picked up 12 basis points on asset yield, reflecting pricing initiatives and improved portfolio mix, along with the impact of an increase in interest rates. Additionally, our term funding costs rose by 3 basis points tied to the higher rates and more term debt issuance. This strong performance over the past year, in spite of much lower long rates and a flatter yield curve, is a testament to how effectively we are executing on our optimization strategies.

Our asset sensitivity ended the quarter at 5.8% and a 200 basis point gradual rise scenario compared with 6.8% as of June 30. We have reduced our asset sensitivity modestly and expect to continue to be at the low end of the 6% to 7% range given the likelihood of the pace of Fed tightening will be slower than past cycles.

Turning to noninterest income on slide 9, you can see we continued to make progress. On a reported basis, due to the impact of notable items, we grew non-interest income 23% from third quarter 2015. Excluding this impact noninterest income was up 4% year over year. Note that the prior-year quarter had $60 million in benefits from a branch sale gain and the card accounting change.

Results were paced by another strong capital markets quarter where we continued to see nice traction in loan syndication, as well as the impact of establishing our own broker-dealer post RBS separation. We are also regaining ground in mortgage banking. This quarter's results reflect continued improvement in our conforming application mix as well as a decrease in pipeline turn times, all of which helped lead to higher loan sale gains and improved spreads on higher refinance volumes.

You can also see continued improvement in service charges and fees, with progress in both consumer and commercial, which were up 3% and 5%, respectively, with a benefit from higher volumes and improved pricing. Our card fees were down year over year due to the card reward accounting change.

Trust and investment services fees were down slightly. Investment sales were up 14% year over year, in line with higher [SC] account. But as we continued to focus our wealth management efforts on achieving a better mix of transaction and fee-based recurring revenue, our commission revenue was lighter. Other income increased $73 million, almost entirely due to the impact of the TDR transaction pretax gain.

Let's take a closer look at expenses on slide 10. GAAP noninterest expense increased $40 million or 5% linked quarter, including $36 million of notable items, largely in salaries and benefits and outside services. On an adjusted basis noninterest expense increased $4 million, roughly flat with the previous quarter. Salaries and employee benefits expense were down by $11 million.

2Q 2016 included higher payroll taxes and benefits associated with incentive payments. In addition, we brought our headcount down by 200, driven by our top efficiency initiatives. Offsetting the reduction in salaries and benefits, our outside services expense was up from relatively low second-quarter levels, largely related to higher technology outsourcing and consumer loan products origination cost.

As expected, we also saw some more modest increases in equipment and software amortization given our infrastructure investments, as well as a $4 million increase in FDIC insurance costs. In effect, the puts and takes offset each other and we were left with a cost of the FDIC increase.

On a year-over-year basis our noninterest expense increased $69 million or 9%, driven by the notable items. On an adjusted basis noninterest expense was up 4%. Salaries and benefits are up $17 million, largely related to growth initiatives as well as higher revenue-related incentive costs.

Our headcount is down by almost 200 year over year, which reflects how our efficiency initiatives more than offset an increase in the consumer banking sales force, largely in mortgage and wealth. In third quarter 2016 we continued to make progress against our goals, enhancing the Bank's efficiency even as we continue to reinvest in the business to generate future growth. Our efficiency ratio at 63% improved by 3 percentage points year over year on an adjusted basis and 5% over the last two years as we continued to consistently deliver positive operating leverage.

If you look at our balance sheet on page 11, average earning assets were up $8.7 billion year over year or 7%. We generated 10% commercial loan growth. And retail loans were up 5% across multiple product lines. Average deposits increased 6%, reflecting our ability to grow lower-cost core deposits. And you could see that our borrowed funds increased $2.4 billion, which reflects growth in long-term senior debt and long-term FHLB borrowings, which replaced repo and short-term FHLB borrowings as we continued to strengthen our funding profile.

Let's move to page 12, where you can see that consumer banking contributed 7% loan growth year over year and improved yields 22 basis points. Loan growth was driven by education finance, mortgage, and other unsecured retail. Consumer loan yields have increased each quarter this year, reflecting our team's initiatives to improve risk-adjusted returns and the benefit of higher interest rates.

On slide 13 you can see that commercial banking experienced another strong quarter. Commercial loans increased 11% year over year, with continued momentum in mid corporate and industry verticals, commercial real estate, and franchise finance. Our commercial team has improved loan yields by 25 basis points, which reflects an increase in LIBOR as well as a more attractive mix.

Slide 14, deposit costs were up 3 basis points linked quarter, driven by strong commercial deposit growth and rising short-term interest rates. While we are comfortable with this increase, we will continue to find opportunities to balance our desire to grow deposits with the need to defend our margins. On a year-over-year basis, deposit costs increased 2 basis points, as our continued pricing discipline largely offset higher short-term rates.

Next, let's move over to slide 15 and cover credit. Overall, credit quality remained broadly stable during the quarter despite a rise in commercial charge-offs and nonperforming loans tied to energy and commodity-related borrowers. We feel good about our reserve levels in the energy portfolio but expect to see some modest migrations to charge-offs and NPL, notwithstanding higher oil and gas prices.

The remainder of the commercial and retail portfolios continued to demonstrate broad stability, and the outlook for credit performance in 4Q remains positive. The allowance to loans ratio of 1.18% was relatively stable with the prior quarter. Our allowance to NPL coverage decreased to 112% given the bump in NPLs, which have already been incorporated into our reserves.

On slide 16 you can see that we continue to have strong capital and liquidity position. This quarter, as part of our 2016 CCAR plan, we repurchased $250 million of shares from the market at an average cost of $22.60, returning $313 million to shareholders, including dividends. We ended the quarter with a CET1 ratio of 11.3%, which reflects our efforts to bring our capital structure more in line with peers.

As a reminder, our CCAR plan includes the ability to repurchase up to $690 million of shares during the CCAR horizon. So, more to follow.

On slide 17 we provide an update on our key initiatives tied to our turnaround plan. We believe it is important to assess our progress against these initiatives each quarter. We continue to deliver balance sheet growth across the platform.

In consumer, we continue to engage with customers across multiple channels. And we are regaining momentum in mortgage and wealth, although we still have room to improve.

In commercial we are seeing lift in capital markets, benefiting from the establishment of our broker-dealer. And this quarter we took steps to refocus our efforts in asset finance. All in all, good execution across these initiatives is driving our strong momentum.

On slide 18 our TOP programs continued to deliver in benefits. As a reminder, the Company launched Tapping our Potential in 2013 with a Company-wide bottoms-up focus. And we have committed to continuing to harvest ideas to deliver improving revenue and expense trends every year.

These programs have been key to our continued momentum and operating leverage, and enabled us to reduce staff in non-revenue areas and streamline end-to-end processes, while ensuring that we continue to generate good revenue growth, notwithstanding the low rate environment. With TOP II we are nearing completion of the program, with roughly $50 million in expense saves, as well as providing nearly $50 million in revenue benefits on an annualized basis for year-end 2016.

We kicked off TOP III this summer and have already made good progress across all the initiatives. In commercial, we completed the end-to-end portfolio management and processes work and are focused on leveraging data to improve customer retention. In consumer we are particularly pleased with our unsecured lending initiative, and we're also digging in on the brand strategy. And we're ahead of plan on taxes, some of which you see this quarter. Bottom line, we are well on our way to delivering on the $90 million to $100 million we are targeting by the end of 2017.

Let's turn to our fourth-quarter outlook on slide 19. We expect to continue to drive attractive balance sheet growth, and are targeting average loan growth of roughly 1.5% to 2% over the third quarter. We also expect net interest margin to be relatively stable. We expect some continued improvement in LIBOR, along with a benefit from continued shift in asset mix and the benefit of pay-fixed swap runoff to drive these results.

On the fee income front, we expect puts and takes to result in relatively stable trends from our adjusted third-quarter base of $368 million. We expect capital markets to continue to post strong results, while mortgage fees should be down somewhat from exceptional third-quarter levels. Additionally, we may generate some relatively modest securities gain as we position the portfolio for next year.

We plan to continue our discipline on expenses, and expect a modest increase given seasonality. Overall, we remain committed to generating strong positive operating leverage, which has been the key to our improvement in EPS and ROTCE. We expect underlying credit to remain favorable but expect to see a modest build in the quarter for loan growth. And, finally, as we continue to grow loans and return capital to shareholders through both dividends and repurchases, we expect to manage our CET1 ratio to around 11.2%.

Overall, we are pleased that we remain broadly on track for our 2016 full-year operating earnings guidance we provided back in January. A strong balance sheet growth and NIM performance, good expense discipline, and favorable credit has more than offset lower than projected fee income and the lack of Fed fund hikes. Overall, this is a reflection of strong execution and our mindset of continuous improvement.

With that, let me turn it back to Bruce.

Thanks, Eric. Let me just close by acknowledging the good work that Eric has done during his 18 months with us at Citizens. This will be his last earnings call for us, but he will work through mid December staying focused on the 2017 budget and contributing to our initiatives.

We're pleased to welcome back former CFO John Fawcett from retirement to step in as Interim CFO and help through the year-end work. I very confident that we'll be able to attract a high-quality permanent successor. And, Eric, I am confident that you will make a very positive impact over at State Street.

So, with that, Daniel, let's open it up to the questions.

(Operator Instructions)

Ken Zerbe, Morgan Stanley.

Thank you. Good morning.

A question on the net interest margin. Obviously I heard you say it benefited from the higher LIBOR this quarter. I think I heard your expectations was that LIBOR was going to continue to increase. But from a planning perspective or forecast perspective, if LIBOR does start to tick lower, for whatever reason, does that also imply that there is a direct correlation to NIM? Or was there any way to lock in those gains? Because I think Eric may also have mentioned reducing asset sensitivity. Was that part of this? I just want to make sure I'm clear on if there is anything that you can do to protect that NIM.

Ken, it is Eric.

I think the NIM for fourth quarter we expect to be relatively stable. LIBOR will clearly be in a tight range. They slowed up a little bit in anticipation of the Fed rate rise. But I think there is little movement that we expect beyond that, that I think you or others should be concerned about.

I think what we have, as we considered the fourth-quarter guidance that we gave, is we might get a little bit of uptick from the front-end LIBOR, which helps reprice the pricing in our commercial loan book. We have some old swaps rolling off, so that will be a tailwind. And against that we just have the back-end long-term rates continuing to flow through the securities and the fixed-rate product portfolio. So, net-net, there's offsets between those and so we expect a roughly flattish fourth quarter.

I would add the other positive tailwind is our efforts to just keep shifting the mix towards better risk-adjusted return portfolio. We are not really that sensitive to LIBOR, Ken. I'd feel pretty confident in that outlook for fourth quarter.

Got it. That is pretty clear. So it's defensible even without LIBOR expectations changing. Okay.

And then the other question I had, just maybe more of a broader question. On the top three expenses, obviously took some cost this quarter. I am aware that your expense guidance includes the underlying top three costs. But maybe just to help us get a sense, what does it cost to implement, say, the top three program ex the one-timers this quarter?

Ken, I think the way I would describe it, there are really two types of costs that we incur as we prepare for expense efficiency work. The first is that we do a lot of leg work, both internally and with some amount of external consulting support to determine what kind of opportunities we have, in which areas and businesses and functions, which processes, which parts of our business. So, there is some preparatory work, and you saw that come through and I think we called that out in the expenses, the higher expense of this quarter which cost about $6 million. In addition, once we do that preparatory work, we need to take severance and reserve effectively for the anticipated headcount actions. And then as those actions take place, those costs bang up against the reserve, and you won't see the impacts of that in the forward period.

So, bottom line is, you'll see most of the expense preparation and severance this quarter. That is what we've called out. We don't expect that to be significant going forward. But you'll start to see the benefit build over the coming months as we actually effectuate some of those headcount actions, in particular, which will benefit starting in the fourth quarter and more and more into the coming year.

I would just add to that, Ken, if you look at slide 18 where we detail the top three programs and break it out into revenues, expenses, and taxes, you've got pretty much the costs associated with the bottom two, with the expenses and the tax work already reflected on the revenue initiatives. The one that will have some costs that go with that is the unsecured lending initiatives. So, as we seek to build that portfolio, we will have some marketing costs that go with that. But that will just flow into the run rate. And those benefits that we are showing are net benefits. I think, to Eric's point, we have reflected most of those costs at this point.

All right, perfect. Thank you very much.

John Pancari, Evercore.

Good morning.

On the margins, just a couple of quick things there. Back to the yield question around loans, barring any incremental move on LIBOR and barring any move by the Fed, generally what is your expectation for the trend in underlying loan yields? Is it still up because of the tail wind on swaps on the rolloff? Or is the downside pressure still there as new money yields are coming in below portfolio yields? Thanks.

John, it's Eric. Let me give you the color.

I think we expect loan yields to continue to inch upwards. The biggest driver of that has been, over the last couple quarters, a mix shift, in particular in consumer. And earlier in the year it was the uptick in LIBOR which helped the commercial loan yield.

So, as we think about fourth quarter, we think we can continue to drive that mix shift, which is worth a couple of basis points of yield on our book. And then we will just have to see whether LIBOR floats up or not. I think that what we always have to consider is that as we grow the balance sheet we also incur some deposit costs. And at this rate of growth those inch up a little bit, as well. We're obviously actively managing that. But between the two of those effects, I think we expect to be roughly constant into the fourth quarter.

Okay. Thank you, Eric.

And that does dovetail right into my related question, on, that was the deposit cost. They did inch up quarter. And, again, that is just given the overall growth and the fact that you don't have a ton of extra room there on your loan to deposit ratio?

I think the way I would describe that is that if you're growing deposits at 3%, 4% at market rates, which many other banks are doing, then you don't expect much growth in deposit costs because it is kind of BAU going forward. I think we are growing our balance sheet at closer to 7% of loan. We need to fund that with deposits.

We found, we have made a conscious choice to increase deposit balances on the commercial side. We found that there are lower costs there than retail in aggregate, and on the margin. So, what you find this quarter, for example, we added north of $2.5 billion of deposits quarter on quarter, even more year on year. When you're growing on a year-on-year basis of commercial deposits in the 10% to 15% range, what ends up happening is you end up paying a little more on some of the new money that you're bringing in. Is it manageable? I think we've demonstrated that it is. But it will trickle through the deposit costs and we will just continue to be careful as we bring in those funds.

Okay. Great. Thank you.

Geoffrey Elliott, Autonomous Research.

Hello. Thank you for taking the question.

You've clearly had quite a lot of growth in the other retail category. I guess some of that is down to things like the iPhone upgrade product. Can you give us a sense of what you think the destination looks like in terms of mix? How much further do you shift towards that other retail category?

I'll start and then I'll let Brad augment.

We think that this is a good important element of our mix shift, that we were underweight higher-yielding portfolios in credit card and in personal unsecured. So, we have, really, a two-pronged effort here. One is the partner financing, which we have with Apple, which may be able to be extended to other partners. And then we have a direct unsecured effort, largely in our footprint, where we think we can also, largely for our credit card consolidation offers, offer a good useful product to our customers. Those initiatives are helping to grow that. I think in the quarter we've grown that about $150 million, which is nice to see. And that is helping to adjust our overall yields favorably.

Brad, maybe you want to add to that.

That's right, Bruce.

I do think there is some opportunity in the other partnership areas. The other highlight that I would make in terms of other consumer categories that's been helping drive up the margins on our loan portfolio, in student lending, we continue to have a lot of good progress there. Our education refi product has a lot of demand, third quarter with roughly the [pin] school product because that is a seasonally high period for loan demand. So, I think good opportunity in both the student loan space and in the other unsecured space.

And then at the other end of the spectrum, on shifting around the loan rates, the aircraft leasing portfolio that you placed into runoff, what was the background there? What was behind the decision to move that into the runoff category?

Maybe I will start and Don you can augment that.

We took a hard look at the overall asset finance portfolio. A lot of the business that we had on the books was sourced by RBS. They were the credit provider to large companies, investment grade companies. And this was a cross-sell that was actually booked to Citizens, as we were part of the same family. And when we stepped back and looked at the book, we said, we have got these large aircraft leases, which are usually the sole product we have with those borrowers and we aren't going to really be relevant to those borrowers going forward. So, they weren't penciling out from a hurdle rate standpoint. And on an E3 basis the returns were not very attractive.

So, we put those into runoff. We'll shrink that book and start to focus more on using leasing as a cross-sell into the middle market and into our mid-corporate customer base. So, it is really an overall strategic shift, and it is basically cleaning up some of the things that are part of our legacy and our history.

But, Don, you can maybe add to that.

Bruce, I think that is right.

And I think it is the last step in the cleanup as we become a public company. Asset finance is something that we've been looking out for the last year, year and a half. And we're really targeting the business completely differently than we have been in the past. And I think it was the one business where we had a very significant mix of non-core Citizens franchise exposures, and this is the cleanup to move those away from the ongoing business.

You might, Don, just take the opportunity to talk about some of the other separation initiatives in commercial from RBS, because we've made real progress this year in terms of setting up a broker-dealer so we can offer underwriting on our own without RBS. And then also doing a great job of getting a new platform in global markets so we can offer FX and risk management products on our own away from RBS.

Yes. And I think I talked about this at the conference about half a year ago, which is, we were losing portions of our profitability in the commercial bank just because we were paying away good offer spread in the trading room, and we were paying away portions of our fees on the capital market side. So, actually completing the infrastructure build across our dealing runs and also across the broker-dealer, you are seeing it come through in the results already. And we're highly optimistic as we move forward.

So I would say, we are finished in terms of the investment in splitting away, save a couple of minor items. And we're operating fully independently right now and should be able to capture the profitability.

Thank you.

Erika Najarian, Bank of America.

Hi, good morning.

I was hoping you could help us think through, if the Fed did raise rates in December, what the impact would be on first-quarter net interest margin based on how your balance sheet is positioned today.

Erika, let me start with that.

And I think you could go back for broad context as to how this affected us last year because, if you remember, it was literally 11 months ago. So, soon we will be to another December month where the Fed raised rates 25 basis points. And I think you saw some good performance starting into the first quarter.

I think mechanically what happens is the Fed raises rates, and then what will tend to play through is that those rates flowed up on a LIBOR basis. The LIBOR rates then are tied to our commercial lending book. 85% of our commercial lending book reprices. They tend to reprice in arrears so part of the book will be priced starting January, another part in February. But we will get a nice bump into the first quarter as a result.

I think what we previously said is that a value of 25 basis points on the front end of the curve is worth about $65 million. The challenge is, and we learned that the hard way, as they say, this past year, is that as the back end of the curve moves up, down, sideways, or twists, that can have some other effects, including some headwinds. And we obviously had good-sized headwinds, like other banks had on that this year.

So, I think the question will obviously be, will the Fed raise rates. There's a lot of anticipation there, but there's been anticipation before. And then the question is what will happen to the rest of the curve.

If my memory serves me, Erika, I think our sequential improvement in NIM from Q4 last year to Q1 was about 9 basis points. And we attributed about half of that to the Fed bump and about the other half to our own initiatives in terms of asset mix and controlling deposit costs. Just for reference sake.

That is good. Thank you.

And just a follow-up to that, to your point, if the Fed raises rates but there is no change in any other part of the curve, is there enough left on the balance sheet optimization initiatives that you could keep your net interest margin stable at that level for the rest of 2017?

Erika, we're still going through our 2017 planning, as Bruce mentioned, spending a good bit of time here with Brad and Don and our treasurer to do that. And we will give more fulsome guidance in January when it comes to NIM.

What I would say is that a boost in the front end should be a positive, should help with an uptick to NIM. Our loan mix initiative should continue, that Brad has been shepherding. So, we expect that to be a positive. The challenges on NIM will continue to be intense competition on the commercial side, which Don's team has been navigating through quite well. A little bit of deposit cost will float up, as well, as LIBOR comes through, and as we grow deposits a bit more quickly than the market. And then it will largely depend on what happens with the back end of the curve. Does the 10-year stay at where it is today, which is certainly a possibility. Does it float back up to where it was? Remember where it was a year ago, it was quite nice when it was at the 2.20 level. Not only 2, but 2.20. Or does it stay where we are, or does it move in another direction?

I think that is the big open item. And I think, to be honest, we will see more of that develop through December and early January, and that will help us give you some good guidance into 2017.

Okay. Thank you.

Ken Usdin, Jefferies.

Thanks, good morning, guys.

If I can ask a question on credit, which has stayed very good for you guys and for everybody else. There's a couple things going on inside the provision. It looks like you still had some of the energy cleanup coming through. But also it looks like you had high recoveries this quarter and a pretty sizable commercial side release. So, I'm just wondering, there's a lot of moving parts in there. Can you help us understand the kind of magnitude of the delta in provision we could expect going forward? And how that ties into the fact that you guys are still growing loans at a really great upper single-digit pace?

I think the credit cost if you look at it across the year has been relatively stable. So, there's some underlying shifts. We had a lower charge-off quarter last quarter. We've moved back to the levels we were at in the first quarter. We have had loan growth, which is adding to the provision, but we've had back books cleanup in terms of credit quality, particularly on the consumer side, which has provided an offset to that.

So, we have been tracking in a mid-80s to 90 range. And I think that's a reasonable expectation. We have guided here to very slightly increased provision in Q4 because of the anticipation that we're going to grow loans in the 1.5% to 2% range. But I don't see anything that is troubling or concerning at this point on the credit front.

Bruce, as a follow up, then, it just seems like you still have some of that back book improvement that can carry forward, as well, where you might be able to still fund the loan growth build with the cleanup on the home equity and some of the legacy stuff that you refer to?

I think, Ken, we have been reasonably surprised because just when we think the cupboard is as clean as can be, we still see some things that break our way. Again, to Eric's point, we haven't given guidance yet on 2017. We'll see how long we can sustain that into 2017. But I think certainly into Q4 we think that we can have an offset to the loan growth.

Understood. Okay.

And then just one quick one, as far as the loan growth is considered, anything changing as far as what you're seeing in terms of the mix of new production and where you want to see the book continue to grow as you look ahead?

I think that the shift you are seeing is all intentional. Over in the consumer side we're seeing good growth in our education refinance product and we're seeing purposeful growth in the personal unsecured side. We've seen, I think, some very good growth in mortgages, which is helping to offset a little bit of the paydowns on the HELOC area. And then on the commercial side we've had some very steady growers throughout the year, at the larger end of our customer base. The mid-corporate and industry verticals have been growing nicely. Our franchise finance business has been growing nicely. And commercial real estate has been having steady growth, as well. I don't think we'll see much change there in terms of the mix and the drivers of that growth. But we're fortunate that we have been able to consistently achieve good loan growth, which has outpaced our peers, and we think we can continue that.

I don't know if Brad of Don, you want to add to that?

Not really, Bruce. I think you covered it well. The only thing that I might add to that is, the one area of our portfolio, which is somewhat intentional, that's not growing is the auto business. We're comfortable with the size. It's a very tight margin business right now and we're holding that a little flat and the growth is coming in the other areas.

Don, anything?

No, I think you got it. I think the place we'd like to see a little stronger growth is our middle market. But it is just very sluggish loans in that sector and being made up with the other sectors.

And in leasing, given the repositioning, that is likely to be a stable portfolio, as well.

Okay. Got it. Thank you.

David Eads, UBS.

Hello, good morning.

I know it's fairly early in the process, but I'm curious if you have any comments in reaction to the potential changes to the CCAR process, taking out the qualitative test. Basically, does that change the way you think about how you might -- the pace of potentially bringing down capital ratios, getting more in line with your average?

I'll start and, Eric, why don't you chime in.

Look, we are pleased to see Governor Tarullo's remarks and acknowledgement that banks under $250 billion in size don't have to go through some of the same rigor as the larger banks. I think, having said that, there were a lot of advances in terms of approach and risk management that will continue. I think the supervisors would expect us to continue a fair amount of that. Being out of the drama of whether you have a qualitative pass or fail is a nice think in and of itself. It will just go back into the supervisory process.

I think our philosophy on gliding down that capital surplus has been sound. We are a relatively new company separated from our parent. So, we're still demonstrating our capabilities as an independent bank. We have been in a fortunate position where I would like to say we could have our cake and eat it, too. We've got very robust loan growth. We have very robust returns of capital to shareholders. And having that capital cushion behind us allows us to continue that, which is really helping to drive these very favorable results. It is important that we get our ROE to higher levels so that we can sustain that kind of an approach on a standalone basis once the cushion is gone. So, we're really just calibrating how fast to glide that down with what the potential we see out in the marketplace to continue to execute our strategy.

Eric, any further?

I would just add, in the near term the focus on putting capital to work in the right places, and recycling it from other areas is paramount, that we can do and control. And I think you have seen evidence of that. I think you have seen how that has actually helped our ROTCE. Our ROTCE has been driven by operating leverage but also by the redeployment of capital. Over time, you have seen us slow down on our CET1 ratios, but we're not in a rush and we want to make sure that we run a safe and sound institution. But I think you have seen a trajectory there of about 50 basis points over the past year. And that can give at least some indication for the time being.

All right. That is helpful.

And then following up on the lease business and the asset finance, I noticed that on your strategic initiative slide, that is still highlighted in yellow. But it sounds like the [best engine] is that you are done with carving out any particular portfolios and now it's just a function of growing the middle market leasing franchise and growing the revenue opportunity from here. Is that correct?

Yes. If you think about that portfolio, we had about $6 billion of assets, broadly. We've moved about $1 billion of these aircraft leases into non-core and put them into run off. We have another of our own low-yielding book of leases that we're just going to manage down. So, I think the steady state portfolio is going to be around low $4 billions -- $4 billion to $4.25 billion. And over time -- the duration on that portfolio is about four years -- we will continue to turn that and target that towards our existing Citizens customer base.

A lot of that was spoon fed to us from RBS and we need to actually integrate this into our offerings with our customers. I would say we call it yellow because we are at the last stage of the thought process to restructure it, and now we have to reorient the business and get the calling in place and the coverage bankers to really understand the product and have a targeted plan where we can expand the product into that customer base. But I think you should start to see that move towards green now that we have really figured out what we want to do with it.

Don, anything further?

No, I think that is right.

The only other comment I would make is, one of the reasons we like the leasing business is it is a relatively quick engagement with our clients. Particularly where we're dealing with prospects, we can begin to do business with them much more quickly than we can, for example, with a revolving credit or term loan which tends to take 6 to 12 months to establish that relationship. We think it's a quick term product which allows us to make some progress on our growth of the client base also.

Yes. Good.

All right. Thanks so much.

Vivek Juneja, JPMorgan.

Hello. Thank you. Great job in moving from 6% ROTCE to 8% very quickly in two quarters. Bruce and Eric, I want to follow up a couple things. Capital return -- what is your thinking now about going above 100%, as you got pretty close this year, the CCAR 2016?

We just answered some perspective on that, but again, we'll wait until we get to the next year. I think we've been on a reasonably good glide path in terms of high return to shareholder and also funding robust loan growth. And we'll see if there's opportunities.

It's less of a litmus test and a barrier than it was in the past. But I think what we've been doing in terms of gliding that CET1 ratio down 50 or 60 basis points a year for the last two years has served us well. And we certainly still have more room to go on that with that strategy, given that the peer average is in the low 10s and we're in the low 11s at this point.

Right. And where do you think, just based on 2016 now, where do you expect, if you could just remind us where you think your B3 fully phased and CET1 will end up by next June?

I don't think we've guided that yet, Vivek. We have offered 11.2 as of the year end. And if you look at the strategies that we've employed, if we have been going down, call it 50 or 60 basis points, if you ran that out another six months and assumed more of the same, that would get you down to something like 10.9 or something, which would have a 10 handle instead of an 11 handle.

Right. Okay.

A question on the consumer banking fee income side: if I look year on year, put aside mortgage banking, which is obviously up very nicely with the volumes carved, consumer banking fee income is still down. Can you talk a little bit about what you need to do there to get that going in the direction you have been trying to?

Which one? I'm sorry, I didn't hear you.

Consumer banking fee income, when you look at the consumer segment and look at the non-interest income year on year.

I will start and, Brad, I want you to chime in.

Part of this is the card accounting change, Vivek. I think, really, you would be better served to focus on the individual line items. We've had some growth in service charges. We've had very strong growth in mortgage. Probably the one disappointing area to date is on the wealth fee line. Having said that, we feel quite positive about what is happening in our wealth business. We have a strong new leader for that business and we've had very consistent success now in growing our financial consultant force. We added another 11 this quarter. We have revamped our product set and reoriented the customer targeting more towards mass affluent and affluent.

So, we're really focused a bit more on fee-based products than traditional commission products. And that is reflecting a little bit of a drag because you make more money right upfront off your commission products and you build a book on your fee-based products. I'd say the proof in the pudding here, our investment sales year on year were up 15% versus a year ago. So, the sales effort is tracking to the growth in FCs and the better penetration of the customer base. But there's a mix change in the product which is holding back revenues a little bit for the short term. But in the long run it's a good thing.

Brad?

On the wealth aside, Bruce, there's not a lot more to add there. I think you said it exactly right. We feel very good about the underlying drivers. We're adding financial consultants. They are high-producing financial consultants and their sales are strong. As you said, it is just a matter of changing the mix, and in the long run that's a good thing. So, I think we are a little behind what we originally thought. I think we are building the right foundation for it to move forward.

The only other comment I would make on the consumer fee is that the question dismissed the growth that we've had in mortgage, and, to some degree, rightfully so. Everybody's seen strong mortgage and refinance activity. But I don't want to quickly dismiss that because there is a really strong underlying trend. We had said for a few quarters that we have to slow down on our hiring because we had to get our operations where it needed to be. And we feel like we've accomplished that. And we have had two really strong quarters of hiring mortgage loan officers.

So, we do believe, even after the mortgage refinance slows a little bit, that we will be able to see pretty strong mortgage fees into the future. So, I think there is some good underlying trends in mortgage, as well.

Okay, Brad, we will have to hold to that next couple of quarters. Thanks.

Jesus Bueno, Compass Point.

Hi, thanks for taking my questions.

Obviously it's a seasonally strong quarter for students. It looks like you had very good growth there. You've had an emphasis on your in-house product. But if you could just give us an update on how your organic originations were and also on the SoFi purchases for the quarter?

Brad, do you want to take that? Student, obviously, refi has really been the focus, but the seasonal in Q3, and then also the SoFi relationship where we're continuing our flow agreement with SoFi.

Actually really strong across all three dynamics. We talked about it early on. This is a really strong seasonal quarter for in-school, so we saw a nice pickup in in-school activity. It is just a product that it is a matter of continuing to inform consumers about the opportunity, and continues to show good growth. And we think there's a lot of opportunity to continue to market that product. And there's a little bit more awareness in the marketplace around the --

Interestingly, SoFi is helping to raise the awareness, which has a halo effect for us.

That is exactly right. And, as you said, Bruce, we did do another SoFi purchase in the third quarter. And we continue our relationship with SoFi. So, we continue to expect to see good growth in students into the future.

It is Eric.

I would just add that the organic mix is almost 95% organic at this point, because what is happening is, while we still have a flow agreement with SoFi across the Bank, and it is quite high in consumer itself, because we have purchases from past years that are starting to mature and roll off, those are just getting replenished.

As an example, our SCUSA portfolio is really just replenishing run off. And we were 91%. Our mix of originations was 91% organic, 9% purchase. So it's a strong organic mix.

Excellent, thanks for the color there.

And, just quickly, on the iUp program, you have had the program there now for a year. I know this quarter we only had a couple of weeks of the new iPhone launch sales. But credit-wise, now that you have a year in, how has that portfolio performed relative to your original expectations? And if you could possibly update us on the breakout of the balances for this quarter and your expectations as we move into the fourth quarter, which is generally heavier for iPhone sales.

The credit experience has been as expected. So, there is nothing noteworthy to report on there. In terms of the breakout, we're really not breaking that out. I think it is fine to just leave that as a category because ultimately we will have potentially more partners. And then our direct personal unsecured has very similar yield characteristics. So, we will report that as a group.

I would say, though, that we would expect the iPhone to be a real driver as we head into Q4 here, that there should be some good momentum behind that. But there's also momentum in our personal mailing campaign that we have underway, as well. So we see good momentum across both fronts.

The category itself, all the unsecured, was up about 30% in the quarter. So, it was a good quarter.

Okay. And if I could squeeze one more just on the tax rate. I appreciate the guidance for 4Q that you put in there. In terms of what to expect as we move into 2017, would you say this is closer to a run rate tax rate that we should expect?

It is Eric.

Let me give you a little bit of perspective on tax rate. We started to work on taxes, I think, in an industrious way in the springtime and folded it into our top three initiative. And you're seeing some of the early returns on that. And I think we're doing what the other regional banks are doing. There is nothing special here. We are availing ourselves of federal R&D tax credit, state investment tax credits. So, what you saw this quarter was a little bit of a catch-up activity from the prior year.

I think going forward what you will see is the annual version of those tax programs, plus the standard tax benefits that come from the LIHTC, the low income housing tax credits. We do a modest amount of wind farms and some other tax-advantaged investing. And we'll continue to do that.

I think we had a particularly strong quarter this time around. I think you saw that we've guided to 31.5% for next quarter. So, down now 150 basis points from that 33% area that we were running at. And if you think about it, it's just part of the benchmarking and review of how do you optimize a regional bank and include ROTCE. Part of that is operating leverage, part of that is fee income growth, and part of that is operating with an attractive tax rate. So, it is part of that continued effort. I think in terms of next year, we will give a little more guidance in January as we pull together our plan. But I think clearly we're on a nice path here.

We are on a trajectory that we want to have sustainable. All of the things that Eric mentioned: getting our NIM back to the pack and getting our capital ratios back to the pack, getting our tax rates back to the pack, those things all contribute to getting our ROTCE where we want to take it.

That is great. Thank you for taking my questions.

Gerard Cassidy, RBC.

Thank you and good morning.

Bruce, you mentioned in the sale of the TDRs just over $300 billion. If I recall correctly, you had just over $880 billion or so at the end of the second quarter. Should we expect additional sales of TDRs in the next couple of quarters?

It's Eric.

I think as you think about TDRs, we, like other banks, you go back over the historic portfolio, you do primarily a one-time review, and you package a nice-sized sale. The bigger the sale, the better execution you tend to get. But I think this is more one-time than otherwise. It doesn't mean that a year or two from now there may not be a little bit of follow-on. But I think you think about those as small and this more as an episodic event, a positive episodic event, but one nonetheless.

Okay, thank you.

Sticking with the sales theme, obviously you moved some of these aircraft leases into run off portfolio. In view of CIT's recent sale of their aircraft leasing business, would you guys consider selling off that portfolio at some point in the future? Or are you just going to leave it in run off?

It is a very different ball game. The CIT was commercial aircraft with commercial airliners and these are private planes for large companies. And they are pretty bespoke and they're one-off. I think what you end up doing is you work them through with the lessees. I don't think this would lend itself to a transaction.

Thank you. I appreciate the color.

Matt O'Connor, Deutsche Bank.

Good morning.

Just a follow-up on the commercial loan growth. Obviously, again, a bit stronger than the industry, and I think some of it is the investments that you've made in some of the verticals and some other areas in recent years. But just how sustainable do you think the above-average growth is? Because there seems to be some pricing issues some places, less demand in some areas, and a number of folks seem to be pulling back for one reason or another, or just having weaker growth.

Let me start, and then Eric or Don feel free to chime in.

I think if you look at maybe the last several quarters, going back 10, 12 quarters, we have had consistent levels of growth. We have largely been tracking the Fed H8 data. We are growing consistent with the overall market. Part of that has been getting back on offense, part of it has been hiring more coverage bankers and building out these industry verticals, and they're bringing relationships to us. And just being very selective about where we are playing, building real power alleys of strength, and then going out and taking on the business.

I would say we feel that we are well situated to continue that strategy. We saw a bit of a seasonal slowdown in Q3. We are looking for a bit of a bounceback in Q4. I think there's a little bit of election uncertainty that may be holding some companies back, which might resolve itself as we get through the quarter.

But I will stop there. Don?

I think you should expect to see us grow with the industry. And we are getting some production out of people that we have hired over the last couple of years as they've gotten in their seats and engaged with the clients. I would say the other thing is, it's deal by deal, company by company. And it is very aggressive out there. We're being careful to balance credit, terms and conditions, pricing, and loan growth. So, we manage it on a multi-variable equation, obviously. And we want to protect the NIM while we're also growing the loan business. So, it will be a balance as we go forward. But I agree with what Bruce said.

Okay. Thank you very much.

Kevin Barker, Piper Jaffray.

Good morning.

Auto net charge offs increased about 30% year over year. It's been running about 69 basis points versus 50 basis points last year. It seems like there's a little acceleration in charge offs on a quarter-over-quarter basis. Is there any particular trends you want to point to? Was this related to the Santander portfolio? Or just related to your overall organic --?

Kevin, it's Eric, just to start.

I think we had a unusual low second quarter performance in auto. We had done some catch-up on some recoveries and repossessions, the way they flow through. I think if you just look at the trends broadly over the five quarters that you have here, you've got to adjust second-quarter 2016 upwards.

Other than that, we have been running in the $20 million to $25 million of charge offs per quarter. There's a little bit of seasoning going through the portfolio, because, as we do not add net new loans, you do not have that natural drift down of the charge offs that offsets the seasoning of the back book. So, you're just seeing a little bit of that. But I think it is well-controlled. We feel like we're in a good place with auto. We'll obviously see the usual seasonality in fourth quarter. But I think it is in good shape.

I think you said it exactly right. It's a low seasonal quarter. In the second quarter we saw a little bit of pickup from that. Of course, a year or so ago we started to expand our credit parameters. That is seasoning through the book. But overall the credit trends are exactly as we would have expected them to be.

And SCUSA is performing as expected.

SCUSA is performing as expected. If you recall, we actually changed our credit parameters with SCUSA a few quarters back, and we're actually now beyond the peak of the SCUSA portfolio loss curve. So that is beginning to come down.

So, if the macro environment stays relatively benign from where it is right now, where do you think the normalized credit losses will be on that auto portfolio on an annualized basis?

Relatively in the range where we are.

If you think about the charge-off rates that you see in the materials, other than the low quarters, you see some prints in the 60, 70 basis-point range. I think that is where we expect it to level out, I'd say, in the 70 basis-point range, more or less. And then we will obviously have the quarterly seasonality because, remember, that is quite a factor in the auto business. And we think that's what it will be like through modest economic times, as well.

And a quick follow-up on Jesus' comments about the tax rate. Over a long period of time, at what point do you expect to reach peer levels for your tax rate? How long do you expect that to take?

That is a good question. But I think taxes are one of those things that you work on over time and you get better at, and is something that we have every intention of doing. And, as I said, some of it is tax credit, availing themselves of tax credits. That tends to vary a little bit state by state, but there is a federal credit. And then part of it is just the tax-advantaged investments, and there are three or four categories of those. There's the low income tax credit, there is historic real estate commercial tax credit, there are some wind farms, all of which we have begun to do some more of. We will do those in line with what other banks do.

We'll obviously keep an eye out and not do anything that is a little more on the edge because that is not the kind of bank that we are. I think the question is, how much can you bring the tax rate down? You see where the peers are. They are in the high 20% range. But it takes time. And I think we are actually quite pleased with the performance so far when we were at 33% for a number of years when tax rate management wasn't a big important item under the RBS umbrella because of the global bank structure. Now that it is, you have seen us go from 33% to the 31% range. (Multiple speakers.)

Our income is growing very quickly, so that income comes through with the marginal rate. So, you're also, some of your tax planning has to offset that higher levels of income.

I think what we will do is in January we will give a little more guidance as to what we expect in 2017. And obviously some of what you have seen is a down payment on that. And we will continue that. It's hard to estimate long term but I think you can estimate some improvements over time.

Okay. Thank you.

Matt Burnell, Wells Fargo.

Thanks for taking my question. Eric, maybe a question for you.

The securities portfolio was up about 4% quarter over quarter. I presume that's mostly just being driven by deposit growth exceeding your loan growth. But can you confirm that there really hasn't been much of a change in how you're thinking about managing that portfolio?

Matt, it is Eric.

I think the securities portfolio is in a good state right now. It is right size for this bank. It is primarily deposits-funded, which is the way we like it. You saw us tamp down a little bit on the asset sensitivity as we saw some nice rate levels in the late August, early September time period. We will continue to position a bit around the curve as that portfolio throws off some good income. I think we've got a very strong treasury team that's got the capability to manage that in a proper way.

But I think it is properly sized for the Bank. I think it's got a nice mix of MBS portfolios. It's got some [floss] layered in, which provides some more clean duration, so that we also manage the [convectic] characteristics. And then I think over time we've got some ability to do more with the portfolio, as well.

Okay. Thanks very much.

And then just a question on the CFO search. Have you said how long you expect that to take? I realize there is no specific date, but do you have a sense as to how long you think that might take?

Obviously we have begun. And my experience on these things is, they take a few months to identify the right candidate and then lift them and get them situated. I think we would be targeting to have the person in certainly by no later than the end of the first quarter.

Great. Thank you very much.

Okay. I think that's it for the questions. And I would like to thank everyone again for dialing in today. We certainly appreciate your interest. All in all, we feel that we had a really terrific quarter, that we are firing on all cylinders, and feel good about our outlook. Thanks again and have a good day.

Ladies and gentlemen, that does conclude our call today. We would like to thank you for your participation. You may now disconnect.