Citizens Financial Group Inc (CFG) 2016 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Citizens Financial Group fourth-quarter and full-year 2016 earnings conference call.

My name is Brad and I will be your operator on today's call.

(Operator Instructions)

As a reminder, this conference is being recorded.

Now I will turn the call over to Ellen Taylor, Head of Investor Relations.

Ellen, you may begin.

Thanks so much, Brad, and hello, everyone.

We appreciate you joining us on the call today.

Our Chairman and CEO, Bruce Van Saun, and interim CFO, John Fawcett, will begin by reviewing the fourth-quarter and full-year results and then we will open up the call for questions.

We've also are proud to have in the room with us today Brad Conner, Head of Consumer Banking, and Don McCree, Head of Commercial Banking.

I would like to remind you all 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.

And of course, our comments today will include forward-looking statements which are subject to risks and uncertainties and we provided information about the factors that may cause our results to differ materially from expectations in our SEC filings including the Form 8-K we filed today.

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

With that, I will hand it over to you, Bruce.

Great.

Thanks, Ellen.

Good morning, everyone.

Thanks for joining our call today.

We are pleased to repeat another quarter of strong and improving results and a great finish to a year of significant progress and good execution.

We continue to run the bank better every day.

We're taking good care of our customers and we entered 2017 with some nice momentum.

The highlights of the quarter from my perspective were the continued delivery of good top-line growth with 11% year-on-year revenue growth and robust positive operating leverage at 6%.

For the full year, revenue growth was 8% and the operating leverage was 4.2% on an adjusted basis.

The commitment to positive operating leverage has powered improvement in our key metrics.

Our ROTCE hit 8.4% in Q4 and our efficiency ratio improved to 62%.

We continue to execute well on our strategic initiatives and we're making progress on our customer, colleague, and community stakeholder objectives, doing better for all of these key stakeholders.

We also announced an increase in our Q1 dividend of 17%, or $0.02 to $0.14, and we repurchased $180 million in common shares during Q4.

As we look to 2017, we expect our agenda to be largely consistent with 2016.

We have a great playbook and we're going to continue to execute against that playbook.

We are hopeful that the macroeconomic environment may deliver some tailwinds, but we will stay focused on execution and what we can control.

I am going to turn it over to John Fawcett, our interim CFO, to review fourth-quarter and full-year 2016 results.

I will then come back to discuss the outlook for 2017.

First, I would like to thank John for shelving his vacation plans to step back in and cover the CFO duties for a couple of months as we transition CFOs.

It's very much appreciated by me and by your colleagues, John, and it's great to have you back with us during this period.

Thanks, Bruce, and good morning, everyone.

Since Bruce hit the highlights, let me direct you to a few pages in our slide deck for color on our financial results.

On slide 6 on a GAAP basis, we generated net income available to common stockholders of $282 million and EPS of $0.55 per share, which was up 31% year-over-year driven by strong revenue growth of $131 million or 11% year-over-year.

Our net interest margin increased 13 basis points while the efficiency ratio improved 3.5% from the fourth quarter of 2015 to 62%.

On slide 7, we present the results on an adjusted basis.

As a reminder, third-quarter results included $19 million of after-tax notable items that benefited our EPS by $0.04 in the third quarter.

We grew EPS on an adjusted basis by 6% linked quarter and 31% from the fourth quarter of 2015.

The strong focus on operating leverage delivered revenue growth of 11% year-over-year with expenses up just 5%.

We improved the efficiency ratio by over 1% versus the prior quarter at 3.5% year-over-year.

Our results also reflect $180 million in share repurchases.

On slides 10 and 11, you can see the continued benefit of our efforts to grow our balance sheet and expand our net interest margin.

We grew average loans 2% linked quarter and 8% year-over-year, reflecting growth across commercial and in mortgage, unsecured retail and student on the consumer side.

Net interest margin was up 6 basis points in the quarter and 13 basis points year-over-year, reflecting improved loan yields partially offset by higher deposit costs.

We've done a nice job of improving our loan yields given our balance sheet optimization efforts along with greater discipline on pricing.

We also benefited from higher LIBOR during the quarter as the market anticipated the tightening by the Fed.

On the funding side, we held our cost flat to linked quarter despite a one basis point increase in deposit costs as we benefited from the run-off of pay-fixed swaps.

On a year-over-year basis, deposit costs were up slightly and net borrowing costs relatively flat.

We remain well positioned to capitalize on the rising rate environment with asset sensitivity to a gradual rise in rates at 5.9% as of quarter end.

Next on slide 12, we cover non-interest income, which on an adjusted basis was up $9 million in the quarter.

Service charges and fees were slightly up and mortgage banking fees were up $3 million, reflecting improved mortgage servicing rights valuation, partially offset lower sales gains.

Securities gains were $3 million tied to portfolio adjustments.

FX and letter of credit fees improved $2 million, largely reflecting increased customer hedging activity given US dollars volatility.

Capital markets fees were strong and in line with record Q3 2016 levels given continued good loan syndication activity.

Let's take a closer look at expenses on slide 13.

On an adjusted basis, non-interest expense was up $16 million linked quarter, reflecting higher vendor contract license and maintenance costs, outside services tied to consumer loan origination and servicing, and an increase in fraud, legal and regulatory costs.

Salaries and employee benefits expense remained stable on an adjusted basis as higher revenue-based incentives were largely offset by a reduction in benefits.

Our headcount is down 75 year-over-year, reflecting the impact of our efficiency initiatives, which more than offset sales force and strategic hiring.

We grew loans 8% annualized with nice performance in both consumer and commercial during the fourth quarter, which you can see in more details on pages 15 and 16.

In consumer, growth was led by continued expansion in residential mortgages, student, and other unsecured retail loans, which was driven by our partnership with Apple and our new personal unsecured product.

We have recently announced a new partnership with Vivint, a major security alarm company, and expect to announce another program soon.

We continued to do a nice job of re-pointing our growth to higher-return categories as the yield in consumer expanded five basis points in the quarter.

We also saw a nice growth in commercial where we continued to execute well in mid-corporate and industry verticals and commercial real estate, which helped to offset the effect of $1.2 billion in loans and leases transferred to non-core.

Yields were up 11 basis points, reflecting higher short-term LIBOR rates.

Next, let's move over to slide 18 and cover credit.

Overall credit quality continued to improve reflecting our focus on growing high quality, lower risk retail loans, paired with growth in the larger company segment of our commercial book, which tends to be higher credit quality.

Our nonperforming loan ratio improved 97 basis points of loans from 105, driven by a reduction in consumer real estate secured.

The net charge-off rate increased to 39 basis points.

Our commercial net charge-offs decreased $3 million from last quarter, while retail net charge-offs increased $24 million, driven by lower recoveries in home equity from relatively high third-quarter levels.

We also saw a $7 million increase in the auto portfolio related to a one-time methodology change.

Provision for credit losses of $102 million increased $16 million, driven by a $14 million reduction in recoveries of prior-period charge-offs from relatively high third-quarter levels.

As we continue to grow to higher-quality retail portfolios and run off our non-core portfolio, our allowance to loans and leases ratio has moved down modestly to 1.15%.

On slide 19, you can see that we continue to maintain strong capital liquidity positions.

This quarter as part of our 2016 CCAR plan, we've repurchased $180 million in stock at an average price of $28.71 and return $241 million to shareholders including dividends.

As Bruce mentioned, we announced a 17% increase in the dividend.

We ended the quarter with a common equity Tier 1 ratio of 11.2%.

As a reminder, our CCAR capital plan targets the repurchase of up to $260 million in shares throughout the first half of 2017.

On slide 20, we show our progress against our strategic initiatives.

We believe it's important to assess our progress against these initiatives each quarter.

Importantly, we continue to drive attractive loan growth across a number of areas.

In consumer, we made good progress over the past few quarters in mortgage, ending the year with 538 loan officers, ahead of our target.

We fine-tuned our auto program to enhance returns and we have seen really strong growth in our education refinance loan product, which has attractive risk-adjusted returns.

In wealth, we have had near-term revenue headwinds as our sales mix is shifting towards more fee-based business, but we have continued to add FCs and our overall transaction volumes are up.

Overall, we are pleased with our results in commercial this year and we expect to continue to build on this strength.

We launched our broker-dealer this year, which allows us to expand our capabilities and deepen relationships with existing customers.

We have experienced strong growth in our mid-corporate and industry verticals with particular success in healthcare and technology.

We look for continued growth in our capital and global markets business given our strong loan syndication capabilities and enhanced interest rate product offerings.

Moving on to slide 21, the top programs have successfully delivered efficiencies that have allowed us to self-fund investments to improve our platforms and product offerings.

In 2016, our TOP II program delivered $105 million in annual pretax benefits across our revenue and expense initiatives.

Our TOP III program launched in mid-2016 is on track to deliver $100 million to $115 million in 2017 benefits.

We will keep working towards delivering greater benefits given our mindset of continuous improvement.

Slide 22 can be read at your leisure.

Suffice it to say that we made good progress across consumer and commercial in terms of customer experience, market share, and product capabilities.

On slide 23, you can see the steady progress we're making against our stated financial targets.

Our adjusted return on tangible common equity of a 8.43% improved 168 basis points year-over-year.

Also, our adjusted efficiency ratio improved 113 basis points linked quarter and 358 basis points versus the fourth quarter of 2015 and now stands at 62%.

And EPS continues on a nice trajectory.

With that, let me turn it back to Bruce.

Thanks.

Thanks, John.

On slide 24, we identify the keys to a successful 2017: Achieving good loan and deposit growth, expanding the NIM, progress on our fee businesses, strong expense discipline and further capital normalization are key objectives, very similar to 2016.

On slide 25, we detail the ambitious guidance that we gave last January for 2016 on the left side of the page and on the right side, we show what we actually achieved.

The good news here is that notwithstanding an adverse interest rate and GDP backdrop, we hit just about all of our targets.

Very proud of the 4.2% positive operating leverage which is near best in peer group.

Only miss was on fee growth, which is taking somewhat longer than expected.

But we feel we are on the right track.

On slides 26 and 27, we detail our guidance for 2017.

Quite similar, you'll see, to 2016 with good top-line growth, 3% to 5% positive operating leverage target, further efficiency ratio improvement and capital normalization.

A few points of color.

First, there's slightly lower loan growth in commercial given higher rates, which is offset by higher securities portfolio growth, so overall earning asset growth about the same.

Strong NIM improvement largely due to yield curve benefit.

There will be slightly less self-help benefit than in 2016.

The provision continues to gradually normalize largely due to reserve build tied to loan growth.

Credit quality is expected to remain very strong and LDR is projected at 98%, CET1 ratio at 10.7% to 10.9% with solid growth in our dividend.

Slide 28 provides some additional color on the NIM.

We expect continued good discipline on how and where we play in the loan book and in raising deposits cost-effectively.

The rate curve as of December 31 delivers a benefit of slightly over $100 million to 2017 NIM assuming two hikes in 2017 and continued steepness in the yield curve.

This obviously will move around on us, so we will see how things actually play out.

On slide 29, you can see the NII walk.

Top of the page is 2016.

Bottom of the page is the 2017 target.

We expect slightly lower earning asset growth and slightly lower NIM expansion as deposit [datas] and borrowing costs rise, but overall, a very strong 8% to 9% growth outlook for 2017.

On slide 30, we show the same format for expenses.

The story again is very consistent from 2016 to 2017.

Underlying expense growth of around 5%, which includes merit and inflation increases as well as business growth spend supporting our strategic initiatives.

This is partially offset by TOP efficiency initiatives of almost 2% bringing the net expense growth to around 3% to 3.5%.

On slide 31, we provide our guidance for Q1 relative to Q4.

This is typically a seasonally softer quarter for us, given several factors, including day count, seasonal activity levels and the FICA taxes associated with incentive compensation.

We also pay our preferred stock dividend in Q1 and Q3 of each year.

That said, we feel good about the year-on-year comparison relative to 2016.

To sum up on slide 32, we feel that we have delivered strong results in Q4 and for the full year of 2016.

We will maintain our mindset of continuous improvement in 2017 and we will look to drive even more TOP program benefits.

We also feel our balance sheet capital and our credit position remain rock-solid.

There's also lots of good stuff in the appendix and supplemental materials, which you can review at your convenience.

With that, Operator Brad, we're ready to open up for some Q&A.

(Operator Instructions)

Matt Conner, Deutsche Bank.

Good morning.

If I could just follow up on the loan growth.

Obviously, you guys have had very strong loan growth and still a solid outlook, a little bit less, though, than you have seen and you mentioned less commercial loan growth given higher rates.

Maybe you could just elaborate on that and then on the consumer side, as we think about the drivers of growth there and maybe less drive from home equity, just walk us through what you think on the consumer side.

Yes, sure.

I will start and then Don and Brad can chime in with some color.

But I think we really hit the ball out of the park with loan growth this year.

And pleased with what we were able to accomplish on both sides, on commercial and consumer.

I think a fair amount of the activity that you have seen on the commercial side has been companies that are taking advantage of lower rates, doing some refinancing, doing some recaps, taking out dividends and putting some leverage back into their companies.

And you have seen commercial real estate very robust.

And so I think as rates move up a little bit, you'll see a little less of that activity, although I do think the, if you see the growth come through that the market is expecting, that hopefully is made up with loan demand that really is in support of a faster growing real economy.

We will wait and see how that plays out.

I think we're just marking it down a little bit, but having said that, I think we have the same coverage force out there taking market share, winning on the battlefield with good ideas.

So we will continue to follow that playbook and then maybe we will see some upside there.

On the consumer side, I think there is also some rates impact that we would anticipate particularly around the mortgage areas, so mortgage refi product.

Obviously, the opportunities there will be somewhat limited.

Our hope is that with the bigger sales force that we have assembled, that we can certainly make up for some of that and that the purchase market will stay strong during the year.

We should also see a little bit of a shift towards more conforming product, which also could crimp the mortgage growth on the balance sheet a little bit.

But I think that's probably the main impact of the higher rates on the consumer side.

There might be a little impact on the ed refi market, but I still think many of the borrowers who are refinancing will still see it worthwhile to do that and then I think on the personal unsecured product, generally people are coming off with very high cost revolving credit card debt into something quite a bit less from an interest rate standpoint.

So I think that will be very modest, if any, impacts on that.

In general, I think we will be looking to follow the playbook that we followed this year and should see very strong growth in the same areas that we saw this year.

But we are being I think just appropriately a little cautious, given higher rates.

I don't know, guys.

Don?

No, I think markdown is the right word.

And we saw a little bit of deceleration on the commercial side as we got to the back and of the year for exactly the reasons that Bruce cited.

We're hopeful, if the economy starts to take off, that we will see good loan demand, but we're just not seeing it in the pipelines yet.

The other thing that's happening in some portions of the portfolio is we're getting a little of the center of mediation as people hit the capital markets with the expectation that rates are going to go up.

That's helping our fee lines a little bit, capturing some --

Pipeline for fees, Don.

Pipeline for fees is good.

So we are seeing a toggle between the NII and the fee line a little bit.

But I think you characteristic correctly.

Yes, Bruce, I think you covered it very well on the consumer side.

The only thing I would add to it is we probably will see slowing growth in auto because we are intentionally tapping the brakes on auto.

We talked about this in previous quarters, which if the pressure continues to be there in terms of the margin and the returns on that business, so that the growth we're getting in the other asset classes and a little bit better risk adjusted returns, we're intentionally pulling back on the growth in auto.

Yes.

Okay.

Okay.

That's good color.

Thank you very much.

Scott Siefers, Sandler O'Neill.

Good morning, guys.

Let's see, so obviously, pretty good margin performance this quarter and the outlook with the first benefit from higher rates.

Just curious, Bruce, what you guys are thinking about deposit costs as we sort of lean into a higher rate environment, I guess.

The only thing that might be a little different about you guys is you start with a higher loan-to-deposit ratio.

But just curious what your overall thoughts are on what you are seeing and what you would anticipate going forward.

Yes.

I will start off and then anybody here can chime in again.

But, I think we have done a very good job of getting better at raising deposits cost effectively.

And so one of the things that we, as we were in the shrink mode in RBS is we pretty much shooed away deposits on a commercial side and they were higher cost.

And we, I think, on the consumer side, had a fair amount of term and time, which we had moved that out as well.

So as we have been growing the balance sheet, we are kind of, I'd say, growing our loan look at about 2X of our peers.

We have to grow deposits 2X our peers given the relatively high LDR after the Chicago region sale.

It's been really important that we get the muscle back in terms of going out to commercial with strategies to raise deposits that have balance in the industries of the banking so that we have the chance and the opportunity to get some cash rich companies to put deposits with us, and on the consumer side, to actually get much better at segmenting the customer base and making very targeted offers to different segments of the base that are appealing.

And just being sharper and not just posting one rate that everybody benefits from and then your whole back book reprices.

I think we have done, we have made real strides in that regard.

If you look at the overall powering costs this year, they are pretty flat.

Deposits costs have inched up a little bit.

But I think on the other borrowing costs, we did some retirement of higher cost sub debt and replaced it with senior debt in term FHLB borrowings.

I think we have done a pretty good job of managing the cost of borrowings overall.

That game plan has to continue.

So again, if we are looking to grow loans at a good clip in 2017, we have to keep staying really sharp on the strategies we have to grow those deposits cost effectively and I think we can do that.

So, anybody, John, Don, Brad, any color on that?

I think in the short time I have been in here and since the first time we did the road show with the public offering, it's always been very clear that we are going to fund loan growth with customer deposits.

From the time that I have been back, it's very obvious there are dedicated programs and disciplines in place to make sure that that continues to happen.

I think it happened this year and with the 9% loan growth.

That was a steep hill to climb and I think it was achieved.

My sense is in the first-quarter, we're doing just as well and deposit gathering is job one.

So, it feels good.

Good.

All right, perfect.

I appreciate the thoughts.

Thank you.

Erika Najarian, Bank of America.

Yes, good morning.

You mentioned earlier that there is likely going to be a toggle between fee growth this year versus NII.

And I'm wondering if you could give us a little bit more color in terms of your confidence in hitting that 3% to 5% non-interest income growth target for the year and what line should we forward to in terms of more contribution for this year?

Yes.

I'd say one of the things you can look at there, Erika, is in the Q4 results, we were up 4% on the year-on-year basis.

I think as the year has gone on, you see some very strong performance on the commercial side.

Capital markets, as we have grown the overall relationships of the bank, we have more swings at the bat.

We have good capabilities in capital markets, particularly our loan syndications area, and we are adding additional capabilities over time.

That's broadening out things like the bond economics that we can now get with our broker-dealer in place.

I feel very good about that.

I think our, what we call global markets, the interest rate and FX risk management products, we have separated from RBS and we have put our own platform in place and it allows us to do a lot more, frankly, than we could when we had to back-to-back everything with RBS.

I think we are poised in condition to continue growing there and we have been helped out a little bit by the environment with the volatility after Brexit and after the administration change in Washington.

Hopefully, I don't wish a lot of volatility on 2017, but I think we can anticipate some.

So that also feels pretty good.

And then also the cash management side.

We've got some great product capabilities.

We keep working to strengthen our core capabilities, but things around our card products and payables are all very strong and have nice growth associated with them.

So, I think we are doing very well on the commercial side.

The challenge has been more on the consumer side, and there I think we have seen some good momentum in mortgage and the hiring I think gives us confidence that we can put up some good numbers again in 2017.

Wealth, we have had the hiring, but we have had a mix shift towards more fee-based product sales, which is great I think for the long-term, but in the short-term, if it's replacing transaction-oriented sales, than it hurts your revenues in the near-term.

We have had a little headwind on that.

I think the lines cross at some point, and again, with a bigger sales force, we should be able to see some growth in wealth next year.

And I think just generally in service charges on deposit accounts, we will continue to see some modest levels of growth if we keep that in the low-single digit range, that helps because that's such a big category overall.

So those are the areas that I would see and I think you can see a little bit of progress there on the Q4 year-over-year numbers.

Got it.

My second question is, speaking of volatility, if we do get some form of regulatory relief this year or next year, specifically as it relates to the definition of a SIFI, a domestic SIFI in the United States, how would you approach capital return differently, if at all?

And what is your view on the potential trajectory of regulatory-related expenses over the next year or two?

Sure.

I think we have to wait and see how things play out.

Our glide path down in terms of managing our capital position to peer levels has been, I think, well thought out and well telegraphed.

And so we have been coming down 40 or 50 basis points a year.

We have pretty much been able to have our cake and eat it too, that we are funding very robust loan growth and are almost 100% returns of capital to shareholders and what we are trying to do, obviously, is get that ROTCE up to levels that are self-sustaining so we can to that and see how in balance as opposed to needing to draw down on that surplus capital account.

I am comfortable with that.

I don't think that the, being de-designated as a SIFI as the level goes up to 250, obviously, we will see what the peers are doing and whether they move down.

We certainly are trying to move towards the peers, so there might be some potential there.

But I feel quite comfortable with the strategy that we have laid out and that we are executing against.

With respect to costs, there could be potentially a little of dividend there depending on whether you can do things, I guess, with a little less exactitude and the robustness that goes into the current requirements.

I think a lot of the whole process is very worthwhile and we will continue to do that.

I think there might be a small dividend, but I wouldn't put it as something that really should move estimates to a material degree.

Got it.

Thank you.

Vivek Juneja, JPMorgan.

Hello.

Couple of things.

Tax rate.

Bruce, given outlook of 32%, I know in TOP III, that's one that you are working on.

Given that, is that 32% in corporate, that benefit?

And if so, why no change from 2016 to 2017?

Well, we are growing income, as you can see.

This year, we grew our net income around 20% and we have, again, some very robust, if you look at the midrange of the guidance, you'd have very robust net income growth again.

And so if the statutory rate stays high, where it is, for 2017, which I think most people anticipate, some of the credit program investments that we are making, the low income housing or the wind farms and things like that, you are doing those things just to keep the rate where it is with the growth in income.

We will keep looking for opportunities.

I think the big event on the horizon would be corporate tax reform because clearly if something gets done this year and it's effective in 2018, with our tax rate at 32%, we could have a real meaningful benefit overall to the bottom line and to EPS and to ROTCE.

We will keep our eye on that, we'll keep working on this.

But anyway, I think that's probably reasonable guidance given the strong net income performance that we anticipate.

Different question.

Capital return.

You obviously had a nice jump in 2016 CCAR.

At what point can we start to think about accelerating that to over 100% capital return?

Yes, well I think I just answered that in the last question.

We will keep our eye on where the peer group is going from an absolute level and where we think the requests of our couple banks that went over 100% in this last cycle.

But broadly speaking, we like over glide path as we are still improving our ROTCE and demonstrating that we are running the bank better and better.

I think that gives us more confidence to, just to keep bringing it down.

But I think we will take that under advisement and see what's happening with peers.

Okay.

Thanks.

Sorry I missed that one.

Just lots of earnings today.

Matt Burnell, Wells Fargo Securities.

Good morning.

Thanks for taking my question.

Bruce, I want to dive into a couple of the comments that you have already made.

One is on slide 20 with sort of the, where you stand relative to most of your efforts across the bank to drive better performance.

I guess I'm just curious in terms of the mid-market businesses, that signal is being not quite fully where you want it to be.

Given the position of the bank as being a mid-market bank, what do you need to do to fully color in that slide, I guess, for lack of a better phrase, in 2017?

Well, I am going to start.

Don obviously can offer his confluence of thoughts on this.

But I think that what we've seen in the middle market, and really, that's just for definitional purposes.

That's companies with revenues up to about $500 million, so call it $25 million to $500 million, that those companies have not grown much over the past few years.

They've been cautious.

There hasn't been quite the level of loan demand that we are seeing with bigger companies.

We have had some very nice growth in what we call mid-corporate, which is companies from $500 million to $2.5 billion.

I think one of the things that we are hopeful of is that if the, and we are hearing this from these investors, is that with the change in administration and focus more on growth, that maybe the animal spirits kick in and we see more loan demand coming from that sector.

I do think we have done a good job of strengthening the client relationships we have in middle market.

We are seeing some modest growth in market share.

We have close the back door and so I think we are doing a good job of keeping clients happy and in the house and we're doing a good job of getting a bigger share of wallet and being able to offer some of our capital markets and risk management products.

So there's some things that we like, but there's also I think a backdrop that that part of the market hasn't been seeing robust growth.

So, Don, why don't you take it from there?

Yes, so I think that's exactly right.

It's just been all about loan demand in the middle market, and I think the, particularly the regulatory environment over the last several years has been very constraining in terms of mid-market companies just engaging in any kind of expansion or M&A activity.

We have had very strong fee growth and very strong deposit growth in our middle market business.

I think as Bruce said, as we turn into 2017, and you begin to get some expansion in the economy, the early indicators coming out of the management teams and the boards of the middle market companies is much more bullish in terms of where they want to take their businesses.

One of the results of the slack loan demand in the middle market has been incredibly intensive competition and very, very tough pricing environments.

So we have been disciplined in terms of where we do want to play and we have seen a little bit of a downward calibration of loan growth because of that.

The other thing we are doing, and I think people may have seen it, is we've hired a team down in the Southeast to expand our business geographically.

It will be aimed slightly higher than the middle market at the outset because we're focused on credit quality as we move into a new region.

But we are anticipating significant client count growth as we go into 2017 and the years beyond.

We are more optimistic than we were this time last year in terms of the environment that we are in operating in and we're confident that our products and services are resonating well with our clients.

Okay.

And then for a second question, I am curious, you all mentioned the higher rates potentially effecting demand on the commercial side for loan growth.

Looking on the consumer side, presumably, the consumer would be a little less affected by a 25 or 50 basis point increase in rates over the next year or so.

But at what level of rates do you think consumers might begin to rethink the incremental dollar of debt that they put on to their balance sheet?

Are we a ways away from that?

Or perhaps not so much?

This is Brad.

I think that really depends on the asset class is the answer.

I think you're close to that point in mortgage because there's been a lot of momentum taken out of the mortgage refi market over the last year or so.

So, you're probably close to that point in mortgage.

I think there's quite a bit of runway left on the education refi loan.

Now, certainly there's going to be tranches of that.

Most of what we refinance in education loans were refiing people out of fixed-rate loans, so you kind of look at tranches of that, but there's an enormous untapped market.

So I think we're still quite a ways away from taking a significant piece of the market away.

But those are really the two areas is mortgage refinance and student refinance where we see there might be some dampening as rates rise.

And I would also add to that that in terms of credit card debt, I would say that's more a function of what people's outlook is than actually sensitivity to the interest rates there.

So if, in fact, people feel that we have a little bit higher growth rate to look forward to for the next couple of years, that unemployment is at low levels and will continue to fall, then I think the confidence of individuals to go out and buy things and sometimes finance it on revolving debt is higher.

Notwithstanding, if the overall cost of debt is moving around a little bit.

I completely agree, Bruce.

And by the way, I would say that same thing holds true in the small business space.

We have seen fairly limited demand for small business loans over the last years, mainly from a confident perspective.

And as that comes back, they'll probably be less sensitive interest rate and we might see some loan demand that comes from just improved confidence.

Yes.

Thanks for the color.

John Pancari, Evercore.

Good morning.

And sorry if I missed a comment on this at all earlier in the call.

But when it comes to the tax reform that could be coming under the Trump regime, can you just give us your thoughts on how much you think could ultimately accrete to the bottom line at Citizens?

Whether it be through any tax benefit or tax-advantaged investments that go away or if you are going to spend any of that potential benefit?

Thanks.

I think most of it falls through, actually, John.

We are operating with the federal rate at 35% and if you got to something like 25% or 20%, that could be a meaningful benefit to, I think, the whole regional banking group, since we are all hovered around maybe 28% to 32% as our tax rates.

There's little global allocation of resources that we have going on.

What we are left with is really investing in federal tax credit programs or state tax planning and it really doesn't move the needle down that far from the federal rate.

So the big benefit is to get the federal rate lower and I don't think the federal credit programs, since they are generally seen to promote investing in some things that are socially good, such as alternative energy or low-income housing, I am not sure they're going to be negatively impacted, but we will have to wait and see how that plays out.

Okay.

Got it.

Thanks, Bruce.

Related to that, though, I feel like a broken record asking this on a lot of these calls, but it's important to get your take.

Do you think that and that benefit that you do expect to accrete to the bottom line ends up getting competed away by the industry at all?

I don't know.

I mean, and, Don, I will ask your view on this.

But I've seen some folks say that if you went into a credit relationship, for example, with a corporate and you were trying to get a after tax rate of return, if the tax rate goes down, then you can offer the credit at lower spreads.

I don't think that's the way the world works.

Because I think the credit right now is offered very thin in terms of returns and the only way you can justify extending the credit is by having an overall broader relationship where you're getting the cash management or you're getting to participate in their capital markets needs or other needs.

And so I think the industry would hopefully hold their discipline there and say, gosh, this is good.

We're going to see an overall improvement on the return on these relationships.

Don?

I think that's exactly right.

As we compete on the credit side every day, we are competing against the public markets and non-banks and other banks.

As Bruce said, I think pricing is very thin in terms of where margins sit today.

So I don't think you're going to see any tax effective change in the returns we generate

Got it.

Thank you.

If I could just ask one more.

I know you commented on your deposit pricing and your efforts around that.

Could you just remind us what has been the beta that you have seen so far from the recent fed hike and then your expectation how that could play out if we see incremental hikes this year?

Yes.

And we have had extremely low betas, which you would expect early on with particularly the December 15 hike.

They were close to zero.

I think the hike that just occurred is probably maybe 50% to 20%.

You're probably a little lower on the consumer side and a little more than that on the commercial side, but kind of blending out to those levels.

And I think you will see a very gradual retracement up towards a beta that overall is probably 55% to 60% as you go back to a normalize natural rate.

But I think you will still see, if there's a June hike of beta that maybe is 30% or 35% or something like that and just kind of inching your way back towards that kind of through the rate hike cycle overall level.

Got it.

Thank you.

Ken Zerbe, Morgan Stanley.

Great, thanks.

Good morning.

You guys have had actually some pretty good growth in commercial real estate.

Just want to -- are you able to tell that you are actually seeing a benefit from some of the increased regulatory scrutiny on some of the smaller, weaker CRE lenders?

Is that a factor in driving your CRE growth or is it just not really relevant for you?

I don't think that's palpable and I'll let Don throw some color here.

But, I think as I said before, when we were owned by RBS, we really stopped doing new lending and started to run our book down.

And then as we embarked on our journey to independence, we said, boy, we are way underweight where peers are in commercial real estate.

An we turned the shop closed sign to shop open.

We turned it around and went back to many of our long-standing relationships and said, hey, we are playing again, and we want to develop a relationship and we are here to stay.

So a lot of this growth that we have experienced has been on the back of both strong growth in the market, but then also regaining some of that lost market share.

I would say that's really why we have been able to grow in the mid- to high-teens for two years in the row.

When I look out to next year, I think we will probably be closer to 10% than at those levels, but we still think that there's interesting projects to do.

The money might be a little more circumspect with the higher rates, but we still see good fundamental demand and we have rebuilt those relationships with developers and added some new ones to boot.

So, Don, you might.

I think that's right.

The only thing I would add, Bruce, is we have hired some key people, which we have been able to build the franchise against.

I think, Ken, the other thing I would say is we have maintained a really high level of discipline about what we will doing in terms of pricing and structure.

So we have actually seen returns in the real estate business creep up as we have grown it, so we have been very disciplined in terms of what we have been targeting.

And I would say that the only thing at margin in terms of the competitive environment, we've stayed pretty consistent through the year and we grew our book pretty straight-line through the year.

We saw some people pulled away a little bit from the market as they filled up their real estate baskets towards the end of the year, so we might have benefited slightly at the margin at the end of the year.

But, as Bruce said, it's really about reinvigorating the franchise, doing some key hires and being consistent in the marketplace.

All right.

Perfect.

Thank you very much.

Kevin Barker, Piper Jaffray.

Good morning.

You guys mentioned that you had a couple rate hikes in your outlook for NIM going forward.

But you also mentioned that you assumed a continued steepness of the yield curve.

Are you assuming that the yield curve stays where it is or that it continues to steepen from current levels?

Well, if you look at the guidance page that we showed, we showed the 10-year in a 250 to 275 range.

So I think there would likely be a parallel shift if we have a midyear hike.

But, it could just be, kind of stay where it is.

But that's kind of what we are baking in here.

We breaking out on one of the slides with the impact is of having the curve move up so that the 10-year is and a 240 to 250 range and we would anticipate that it's likely to stay there and then potentially drift up.

So we didn't see that happen in 2016.

We actually saw 10-year plummet all the way down to 150 to 160, which created some real headwinds.

But at this point, with the 10-year where it is and the curve where it is, one of the nice things we have going on is that as mortgage cash flow comes in off the securities portfolio, we are putting it back out at rates that are either neutral or slightly accretive to what's coming off the books.

And so that's a real help.

So that's baked into our forecast and let's hope that that's what we see.

And then also on that auto portfolio, I noticed your net charge-offs are up roughly 27 basis points on a year-over-year basis.

And you mentioned what 70 basis points was normalized last quarter.

Do you have a new view on a normalized level given that changes in your methodology on assessing auto credit?

You are talking about the charge rate, charge-off rate?

Yes, it should be in the low 50%s would be our expectation.

I think we had this one-time change in terms of how we were accounting for the repossessions which is now behind us and I think we are anticipating stability in the auto charge-off rate going forward.

Yes, Kevin, I would just add if you look at our NPLs as a forward indicator of charge-off levels, go-forward, we think they are at normalized levels this quarter.

So absent the methodology change, where would the charge-off level come in?

In auto, that would have been roughly 3 basis points, I think it was, total.

That's to our total charge-off rate.

You're talking auto, Kevin?

In auto portfolio in particular, yes.

I think to this quarter, would have been in the neighborhood of 10 to 12 basis points for the auto.

Thank you.

David Eat, UBS.

Hello.

Good morning.

I think you talked about expanding some of these consumer lending programs, the Vivint and I think you're going to announce another one.

Obviously, the Apple one seems to be going pretty well.

Can you just give a little bit more color on the trajectory for that?

Whether it can continue growing at a similar level to where it's growing now and how large you would like that portfolio, that total unsecured consumer portfolio, to get?

Sure.

I'll start and pass it to Brad.

But, I think we have had a two-pronged strategy here.

One is the partnership model where we are aligning ourselves with partners and helping them offer the installment credit to their customers.

So, Apple, Vivint, are two of the examples of that and had very nice growth with the Apple balances and I think they feel that we're doing a good job in terms of the customer experience.

So, that's been a great relationship.

And we have wetted the whistle here and said there's another one coming soon.

So you'll just pay attention.

But, we have another one in the works.

But that's one vector.

The other vector has been on just the personal unsecured direct product that we are offering through the branches and direct mail, largely to the footprint.

And it's targeting folks who have high revolving debt balances who can have a debt consolidation opportunity into a personal unsecured loan that offers a more attractive interest rate and we have seen really good take-up on that and I think, again, there we're being very selective.

One of the things that's consistent across these programs is very strong credit discipline trying to keep the FICA scores well ahead of 750 and so I think the risk adjusted returns look pretty good for both sides of the equation.

But, there is still running room, so I think you will see similar growth to what we have seen this year.

Again, next year, we are not bumping up against any limits.

One of the things that we have that we wish we didn't have is a relatively smallish credit card portfolio.

So when you look at the straight unsecured, this is another way to play that game and to get in that game and do it in a way that's more accretive more quickly than if we were trying to build up the card books.

So, Brad?

Yes, Bruce, I think you covered it extremely well.

I think we would expect new growth rates to be somewhat in the range of what we've seen in the last few quarters.

The organic demand for these Apple-like programs continues to be there and when I say organic demand, we have retailers coming to us wanting to talk about the program.

We do expect to had another program very soon and I would say there is a pipeline building of people that are interested.

So, the opportunity is there.

We are being incredibly disciplined to just monitor the early credit results.

So far they look great.

It's a very high prime customer base that we're dealing with, so we continue to get opportunity.

All right, great.

One quick follow-up.

On the deposit beta, when you're looking at that NII outlook slide on slide 29, where you have loan yield and then the higher deposit cost represents about half of that.

Is that implying that you baked in something like a 50% deposit beta in the NII outlook slide and could that be conservative?

Or how do those dynamics play out?

Yes, I think that there could be some conservatism built into that.

I think it's not just the deposit beta.

There's also the fact that we are growing the loan and deposit base 2X versus clients.

So it's hard to discern is it just from the yield curve impact versus the fact that we're growing deposits a bit faster than peers.

I think that's what in that and the good news there is that the NIM should still expand in a fairly robust fashion.

Great.

Thanks for the color.

Ken Usdin, Jefferies.

Thanks.

Good morning.

Hello, Bruce, with the really good progress you are now making on that ROE and your medium-term goal of 10%, given your expectation for rate hikes to happen, just wondering if you could give us any color in terms of do you have a line of sight now on when you think 10% is doable now that we are kind of getting in ear shot of it?

Yes.

I have been fairly consistent that I don't want to get pinned on this because there has been a lot of anticipation of rate hikes or yield curve movement that hasn't happened.

But I guess as background, if you look at the trajectory we're on, we have added about 4% over three years to the ROTCE with very little, if any, rate benefit.

And year-on-year, the ROTCE was up 8.4% in the fourth quarter.

That's up 1.7% from where it was in the fourth quarter of 2015.

And we have had really no rate hike benefit in that.

It's clearly possible that we are in striking distance of the 10% ROTCE if we continue to execute well and we get some hikes that help provide a little tailwind.

But again, I am not going to put a line in the sand and chase it.

I just think if we keep doing what we're doing, we keep executing well, the ROTCE is moving in the right direction and we will get there, hopefully, reasonably soon.

Okay.

And then second question just on credit, which continues to be really good, and I know I heard the comments about expecting some normalization, but where at all you all even see normalization?

It seems like you could still have, with the way that the underlying trends are going, where would you even expect any changes to be happening underneath it on the credit side?

The normalization to me is probably more in the provision line than it is in charge-offs.

We saw a little bit of movement in the commercial side this year from basically nothing to maybe 10 basis points.

Can that move into a 10 to 15 basis point level in 2017?

Sure.

But I still think we don't see any big migrations or anything.

But you have been living on the good side of life for a long time, so you should expect I think a little move higher.

On the consumer side, we basically had less good assets from a credit quality standpoint like our non-core and service by others running off and we're replacing it with really high prime and super prime, fed refi and some of this unsecured, which I think is helping to also improve the overall credit quality on the consumer side.

We had as those cleanups have occurred and those run-downs have occurred, we have benefited from that in terms of having offsets to the normal provision build that you would expect as you are growing the loan book the way we are growing the loan book.

When we give our outlook for next year, I think there might be a little bit of that, less of that back book clean up effect that means that you could see more of a reserve build, but I don't really see tremendous movement at all in the charge-off rates.

Okay.

Thanks a lot.

Geoffrey Elliott, Autonomous Research.

Good morning.

Thanks for taking the question.

On the partnership that you are adding, Apple being one, but I know that are a few others, what are you watching there to make sure that you don't run into credit issues down the line?

What are the early indicators that you can focus on to make sure if you do one of these partnerships and it doesn't work out, you pare it back pretty quickly?

I think the answer to that is the traditional credit metrics, right?

The first is through-the-door credit quality.

So you want EBITDA, the debt-to-income ratio, the FICA scores, that are through-the-door credit metrics, which look extraordinary and then we are incredibly diligent around looking at the early loss emergence curves.

So what do the early-stage delinquencies look like, if any?

What do the early loss look like?

I mean, we can get a feel for a loss emergence curve versus what we priced for within three or four months of the origination.

And I would say we just feel very good about that up until this point in time.

We've got over a year under our belt now with the Apple program.

So we are starting to get a really good feel for how these things mature and develop over time and they're relatively short-term assets.

So you get a pretty good feel early on.

I would just add some color that it seems hard that you can achieve this, but we are achieving it.

It's almost what I would refer to as the hat trick to use a hockey freeze.

But we are focused on improving our asset yields, improving the risk-adjusted yields on these portfolios, and actually seeing if our stress losses picture can improve and we have actually achieved that and it's partly because we have run off some of the higher risk stuff and we're replacing it with better quality stuff.

And so it's been really impactful on the consumer side to be able to achieve that.

One more thing I'd throw in there, Bruce.

Our standard model calls for risk sharing with our partner as well.

So there's a vested interest in our partner, in their through-the-door quality, which is a big factor in these programs.

Just to follow up on that.

There's only one Apple and there are lots of banks out there.

When you are competing for this sort of partnership, what is it that sets you apart?

There must be something that you are doing different or better or pitching better that means they went to partner with you rather than somebody else.

So what is that?

I think this sounds very basic, but I believe it's true, which is being able to provide extraordinary customer experience.

Apple, in particular, but all of the partners that we're working with expect this to be a value-add program and expect us to be able to provide a customer service level that is consistent with their brand and with their own expectation.

And I think we have been able to do that.

We're getting good feedback from our partners that we do that well and I think that's the key.

And obviously understanding the credit risk as well.

I think it's how we do business.

How we look to partner and align with the customer objectives has been good and I think we are of the size that we can, these are very big important relations to us.

And so we put a lot into making that we're doing a good job.

Thank you.

Scott Valentine, Compass Point.

Thanks.

My questions have been asked and answered.

Thank you.

No further questions at this time.

Well, great.

Very much appreciate everybody dialing in today.

We do appreciate your interest and we look forward to another year of focused execution.

So have a great day.

That does conclude today's conference.

Thanks for your participation.

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