Citizens Financial Group Inc (CFG) 2017 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Citizens Financial Group Third Quarter of 2017 Earnings Conference Call.

My name is Justin, and I'll be your operator today.

(Operator Instructions) As a reminder, today's 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, Justin, and good morning, everyone.

We really appreciate you joining us this morning.

We'll start off with our Chairman and CEO, Bruce Van Saun; and CFO John Woods, reviewing our third quarter results.

And then we're going to open up the call for questions.

We're really pleased to have with us today Brad Conner, our Head of Consumer Banking; and Don McCree, our Head of Commercial Banking.

I'd like to remind you all that in addition to our press release today, we posted a presentation and financial supplement on Investor.citizensbank.com.

And of course, our comments today will include forward-looking statements, which, as you know, are subject to risks and uncertainties.

We provide information about the factors that may cause our results to differ materially from our expectations in our SEC filings, including a Form 8-K filed today.

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

And now with that, I'm going to hand it over to Bruce.

Thanks, Ellen.

Good morning, everyone, and thanks for joining our call today.

We're pleased to report another quarter of strong results as our disciplined execution continues to drive strong momentum.

The headline results show that we reached our key medium-term IPO targets this quarter with a 10.1% ROTCE, a 59.4% efficiency ratio and a 1% ROA.

This is notwithstanding a lower rate environment than was assumed back when the targets were set.

While these results mark good and consistent progress, we have more work to do to run the bank ever better and become a top-performing bank.

I believe that the same formula that has taken us this far can continue to propel us to even better results.

We're being very disciplined in where and how we play in our capital allocation.

We have a mindset of continuous improvement that allows us to self-fund our growth investments while delivering superior operating leverage.

We've added some great talent and built out many excellent capabilities.

And lastly and perhaps most importantly, we have focused on delivering a great customer experience in both the Commercial and Consumer segments.

We've launched our TOP IV program, and we continue to solidify and add initiatives.

We bumped our target range by $5 million this quarter.

We're putting a similar governance structure around our balance sheet optimization, or "BSO" initiatives, which will be led by John Woods, our CFO.

Turning to specific highlights of the quarter.

We had excellent year-over-year revenue growth and operating leverage.

Year-on-year, adjusted revenue was up 10% versus 3% adjusted expense growth, delivering 7% positive operating leverage.

NII was up 12% as loans grew by 5.4%.

And the net interest margin improved by 21 basis points, with about half of that due to self-improvement and half due to rates.

Adjusted noninterest income was up 4%, and that was really paced by strong growth in capital markets revenues.

On a linked-quarter basis, our underlying revenue growth was 2.5% against expense growth of 1% for 1.5% sequential operating leverage, which annualizes, of course, to 6%.

NII was 3.5% sequentially -- grew 3.5%.

That was paced by 1.5% spot loan growth and an 8 basis point rise in the NIM to 3.05%.

Our average loan growth was a little lower at 0.4%, which reflects somewhat the sluggish and stretched conditions in the C&I space that we saw throughout a good chunk of the quarter.

But we're cautiously optimistic of a pickup in Q4 continuing on into 2018.

We continue to be highly focused on capital management.

We returned $315 million to shareholders in Q1.

-- or in Q3.

So overall, it was another strong quarter.

We feel good about our positioning, the opportunities that we have in front of us and our ability to execute.

So with that, let me turn it over to our CFO, John Woods, to take you through the numbers in more detail.

John?

Thanks, Bruce, and good morning, everyone.

Let's get started with our third quarter financials which start on Slide 4. We generated net income of $348 million and diluted EPS of $0.58 per share.

Our reported net income was up nicely compared to the second quarter, driven by higher net interest income and lower credit-related cost.

Year-over-year, net income was up 17% and EPS was up 21%.

We also present our results on an adjusted or underlying basis in order to show a clear picture of the operating trends in our business.

On this basis, net income for the third quarter was up 25%; EPS was up 31%; and we delivered positive operating leverage of 7% year-over-year, reflecting a revenue growth of 10% and expense growth of 3%.

Net interest income of $1.1 billion increased 4% linked quarter, driven by loan growth, higher loan yields and benefit from day count, partly offset by an expected increase in our funding cost.

Our net interest margin increased 8 basis points linked quarter and 21 basis points year-over-year.

We will spend more time on the margin in a few minutes.

On an underlying basis, noninterest income of $381 million was unchanged from second quarter and was up 4% year-over-year, while our efficiency ratio improved 95 basis points compared with the prior quarter and 390 basis points year-on-year, excluding the notable items.

We delivered a more than 50 basis point sequential quarter increase in ROTCE this quarter to 10.1%, achieving the IPO base medium-term target of 10%.

This result was up over 200 basis points from the prior-year quarter before the impact of the notable items.

Our efficiency ratio of 59.4% for the third quarter also exceeded our medium-term IPO target of 60%.

We are very pleased with the strong results which reflect continued execution against our strategic initiative and our commitment to focus on continued improvement to drive further revenue growth while maintaining operating expense discipline.

Although we have attained our ROTCE target, we're confident that we can do even more to drive further improvement.

We are constantly seeking to run the bank better and leverage the potential of our franchise.

There continues to be upside from leveraging the investments of the past several years, optimizing the balance sheet and focusing on continuous improvement in how we serve customers and maximize efficiency.

For a few minutes, I'll update you on the status of our TOP program, which will contribute further efficiencies and revenue opportunities while funding investment to drive future growth.

Taking a deeper look at the NII and NIM on slides 5 and 6. We continue to deliver attractive and disciplined balance sheet growth which helped us drive a 4% linked-quarter increase in NII for the quarter.

We grew average loans and loans held for sale by 0.4% on a linked-quarter basis as average retail loans were up 1.2%, offset by a small reduction in average commercial loans, largely reflecting the impact of the sale of $600 million of lower-return commercial loans in the second quarter.

Excluding the impact of the sale, average commercial banking loans and loans held for sale were up 1%.

On a period-end basis, total loans and loans held for sale were up 1.5% linked quarter and up 5% year-over-year.

Average loans and loans held for sale were up 5.4% year-over-year, and I'll provide some additional detail on the growth shortly, including the impact of our balance sheet optimization efforts.

Net interest margin improved 8 basis points linked quarter and 21 basis points year-over-year, which reflects a nice improvement in loan yields, given the benefit of our balance sheet optimization efforts, which included an ongoing mix shift towards higher-return categories and the rise in short rates.

The improvement in the margin included a 2 basis point benefit from higher-than-expected commercial loan interest recovery.

On a linked-quarter basis, consumer loan yields were up 11 basis points and commercial loan yields were up 25 basis points.

An increase in funding cost partially offset the benefit of these higher loan yields.

Deposit costs were higher by 6 basis points, reflecting the rise in short rates and growth in the average Commercial Banking deposits.

Total average deposits increased by 2% from the prior quarter, while period end deposits were down slightly, given an elevated level of commercial deposits at the end of the second quarter.

Our average LDR came in at 97.6%, which was consistent with our outlook.

Total funding costs were up 7 basis points, which reflects the full quarter impact of our $1.5 billion senior debt issuance in May.

Turning to fees on Slide 7. On an underlying basis, noninterest income was stable in the quarter on higher Capital Market fees and service charges and fees, were offset by a lower mortgage fees and a reduction in foreign exchange and interest rate products.

Capital Market fees were a record for the quarter and were up 47% year-over-year, showing continued momentum from the investments we made in talent and broadening our capability.

Bond underwriting was the strong this quarter, given favorable Capital Markets, particularly in September.

We also saw an increase in M&A fees following our second quarter acquisition of Western Reserve.

Most remaining fee categories were relatively stable in the quarter.

Year-over-year on an adjusted basis, noninterest income was up approximately 4%.

This reflects strong contributions from the Capital Markets business, given that expanding capabilities; and higher card fees, which reflects higher purchase volumes along with the benefit of revised contract terms for core processing fees which commenced in the first quarter of this year.

Mortgage banking fees were down as reductions in loan sales gains and spreads were partially offset by an increase in servicing fees.

Foreign exchange and interest rate products fees were also down, driven by a reduction in variable rate loan demand.

Trust and investment sales were relatively stable as we continue to drive improvement in our mix of fee-based sales.

Turning to expenses on Slide 8. On an underlying basis, expenses were up $9 million, largely reflecting higher salaries and employee benefits tied to revenue-based initiatives and higher outside services cost which reflect costs tied to our strategic growth initiative; along with an increase in other expense, which included $4 million in expense associated with legacy home equity operational costs.

Year-on-year, our adjusted expenses were up 3%.

Salaries and benefits expense was higher, reflecting the impact of strategic hiring, merit increases and higher revenue-based incentive.

We also saw an increase in outside services costs tied to our strategic growth initiatives.

We continue to remain highly disciplined on the expense front as we identify opportunities to redeploy expense dollars out of lower-value areas in order to continue to self-fund our growth initiatives and enhance capabilities to serve customers.

Our 3 tier expenses include approximately $15 million for our strategic growth initiatives, including our efforts to improve our retail customer experience, expand our Wealth Management business, broaden our Capital Markets capability and bolster our M&A advisory business.

We funded these franchise investments with about $14 million in efficiency savings realized through our TOP programs and operational transformation initiatives.

In short, we continue to seek opportunities to become more efficient, which allows us to fund our growth initiatives and maintain strong operating leverage.

With that, let's move on and discuss the balance sheet.

On Slide 9, you can see we continue to grow our balance sheet and expand our NIM.

Overall average loans and loans held for sale were up 0.4% on a linked-quarter basis and 5.4% year-over-year, driven by growth in education, mortgage and unsecured retail in the consumer side and broad strength across commercial.

Commercial loan growth was muted by the impact of the sale of $596 million of lower-return commercial loan and leases near the end of the second quarter associated with our balance sheet optimization initiatives.

As I've mentioned, NIM was up 8 basis points in the quarter and 21 basis points year-over-year.

These results reflect further expansion of our loan yields, given our balance sheet optimization efforts, which contributed about half of the year-over-year increase; continued discipline on pricing; and the benefit of higher rates.

We also benefited by about 2 basis points of higher-than-expected interest recoveries in commercial.

Also, we remain well positioned to capitalize on the rising rate environment with asset sensitivity relatively unchanged at 5.4%.

On Pages 10 and 11, we provide more detail on the loan growth in consumer and commercial.

In consumer, we grew the portfolio 6% year-over-year with continued expansion in residential mortgages and education, which is largely tied to our refinance product; as well as continued strength in other unsecured retail loans which continues to be driven by our product financing partnerships and our personal unsecured product.

We are also seeing ongoing benefits from our focus on enhancing our portfolio mix by driving growth in higher-return categories.

As you know, we have been slowing growth in auto, and that should continue over time.

As a result of these efforts, in addition to higher rates, we expanded consumer portfolio yields by 11 basis points in the quarter and 38 basis points year-over-year.

We also saw nice growth in commercial, with average loans increasing 4% year-over-year, where we continue to execute well in Commercial Real Estate, Mid-corporate and Middle-Market, Industry Verticals and Franchise Finance.

This growth is muted somewhat by our efforts to reduce capital historically deployed against lower-return areas, like select portions of the C&I book, where we aren't gaining any cross-sell; and Asset Finance, where we had originated big-ticket leases, given the overall RBS relationship.

The overall goal is to raise returns and build strong relationships while still achieving good loan growth.

The net result in commercial reflect a 25 basis points improvement in yields linked-quarter and a 75 basis point increase year-over-year.

On Page 12, looking at the funding side.

We saw a 6 basis point sequential quarter increase in our cost of deposits, reflecting the impact of higher rates and growth in higher-beta commercial deposits.

We continue to find attractive balance sheet growth at accretive risk-adjusted returns, which is driving NIM higher in spite of these rising deposit costs.

Our funding costs were up 7 basis points sequentially, which reflects the full quarter impact of our $1.5 billion senior debt issuance in the second quarter.

Year-over-year, our cost of funds were up 19 basis points, reflecting the impact of higher rate along with greater long-term and funding.

This compares with overall asset yield expansion of 39 basis points.

We expect a slower rate of increase in fourth quarter deposit costs, given the timing of rate hikes and the impact of some of our deposit strategies.

Next, let's move to Slide 13 and cover credit.

Overall credit quality continues to be excellent, reflecting the continued mix shift towards higher-quality, lower-risk retail loans and a relatively overall clean position in the commercial book.

The nonperforming loan ratio decreased 9 basis points versus the prior quarter to 85 basis points of loan this quarter while improving 20 basis points from the year-ago quarter.

The NPL coverage ratio improved to 131% relative to 119% in the second quarter and 112% in the year-ago quarter.

The net charge-off rate decreased to 24 basis points from 28 basis points in the second quarter with continuing favorable credit trends and results.

Our commercial net charge-offs netted down to 0 this quarter, reflecting an increase in recoveries; while retail net charge-offs were $4 million higher than the second quarter in part due to higher seasonality in auto.

Provision for credit losses of $72 million was $7 million above charge-offs, which include additional reserves for estimated hurricane losses.

The recorded provision was relatively stable compared to the second quarter and down $14 million versus a year ago, reflecting the improvement in commercial due to recoveries.

Lastly, as we continue to increase the mix of higher-quality retail portfolios in our overall loan book, our allowance to total loans and [delinquency] ratio was relatively stable at 1.11%.

On Slide 14, you can see that we continue to maintain strong capital and liquidity positions.

We ended the quarter with a CET1 ratio of 11.1%.

As part of our 2017 CCAR plan, this quarter, we repurchased 6.5 million shares and returned over $350 million to shareholders, including dividends.

Our Board of Directors has declared a dividend of $0.18 a share today, and we have authority through CCAR to increase the quarterly dividend again to $0.22 per share in early 2018, subject to our board's approval.

On Slide 15, we show our scorecard on how we are executing against our strategic initiatives.

We are intensely focused on developing strong customer relationships and growing the franchise in a profitable and sustainable way.

In the consumer business, we are committed to becoming a trusted adviser to our customers through our tailored advice and product strategies.

We continue to build out our Mass Affluent and Affluent value propositions as these are key segments for us.

We are also investing in several projects that will re-engineer critical services we provide to customers.

This should result in improved customer experience and greater efficiency.

We continue to drive attractive loan growth across a number of areas, such has in our education refinance loan product and corporate partnership linked installment credit, which has attractive risk-adjusted return.

As we optimize the balance sheet, we continue to reduce the auto portfolio in order to enhance return.

In wealth, we continue to build scale and add capabilities, highlighted by the launch of SpeciFi, our new digital investment advisory platform.

We also saw continued progress migrating sales mix toward fee-based products, which represented 41% of investment sales in the third quarter of 2017 compared to just 30% a year ago.

We have increased our efforts to reposition and improve the returns in our mortgage business in the current environment.

We trimmed our loan officer headcount by about 10% in the quarter in order to drive productivity and increase our focus on conforming loan mix.

In addition, we are investing in a direct-to-consumer origination platform, which we believe will provide a lower-cost channel to originate conforming mortgages.

In commercial, our expanded capabilities helped deliver another very strong quarter in Capital Markets as we continued to leverage the investments we have made, including an enhanced bond underwriting platform and our recent acquisition of Western Reserve.

Treasury Solutions continued its steady progress with fee income growth of 7% year-over-year due to strong momentum in our commercial card program as purchase volume was up 35% year-over-year, driving a 31% increase in fees.

Our initiatives to deepen customer relationships are helping to drive continued balance sheet and customer growth with 5% average loan growth year-over-year, reflecting strength in Middle-Market, Commercial Real Estate, Corporate Finance, Franchise Finance and Mid-corporate.

We are also starting to see the benefits of our geographic expansion initiatives with strong balance sheet and fee growth in those markets.

The TOP programs have successfully delivered efficiencies that allowed us to self-fund investments to improve our platform and product offerings.

We have largely completed the actions needed for the TOP III program which launched in Mid-2016 and is expected to deliver run rate benefits of approximately $110 million by the end of this year.

Our TOP IV program is a further example of our commitment to continuous improvement and delivering value to our shareholders.

As we work through a combination of initiatives to enhance revenue and to drive efficiencies, we are raising our target for the program by $5 million to a run rate pretax benefit of $95 million to $110 million by late 2018.

On Slide 16, you can see the steady and impressive progress we are making against our financial targets.

As previously noted, this quarter, we hit our 10% post-IPO medium-term ROTCE target.

Since third quarter '13, our ROTCE has improved from 4.3% to 10.1%.

Our efficiency ratio has improved by 9 percentage points over that same time frame from 68% to 59.4%, exceeding our medium-term IPO target of 60%.

And EPS continued on a very strong trajectory as well, up 160% in 4 years to $0.68 from $0.26, with a CAGR of 27%.

This rate of growth and improvement continues to outperform peers over the period as we have made it back to the pack in terms of key performance measures.

That said, we still have opportunities for further improvement and we'll work hard to deliver them.

Now let's turn to our third quarter outlook on Slide 17.

We expect to produce linked-quarter average loan growth of around 1% to 1.25%.

We also expect net interest margin to remain broadly stable linked quarter.

We are expecting noninterest income to be broadly stable, given the record level of Capital Market fees in Q3.

We also expect to realize a modest TDR transaction gain in 4Q which will be offset by cost associated with our strategic growth initiatives.

We will treat those as notable items so you will be able to clearly see the operating trends in our business.

We expect expenses to be broadly stable in the fourth quarter, perhaps up a tad due to seasonality.

Additionally, we expect provision expense to increase to the range of $80 million to $90 million, reflecting loan growth and a modest increase in commercial net charge-offs, given the higher level of recoveries in the third quarter.

We expect our tax rate to tick up temporarily to around 34% for the fourth quarter as a result of an $8 million impact on the tax line tied to the launch of our historic tax credit investment program this year.

The full year 2017 tax rate is expected to be about 31% on a reported basis and 32.25% on an underlying basis, excluding our 1Q of '17 tax settlement.

We expect to manage our CET1 ratio to around 10.9%, with an impressive average diluted share count of approximately 490 million to 495 million.

And finally, we expect the average LDR to be in the 97% to 98% range.

With that, let me turn it back to Bruce.

Okay.

Thanks, John.

And with that, operator, why don't we open up for some Q&A.

(Operator Instructions) Your first question comes from the line of Ken Usdin of Jefferies.

I was wondering, John, if you can talk a little bit more about that balance sheet optimization side.

And specifically, how do you expect that to work through the asset yield side of the equation?

Where are the areas you'll continue to kind of move out of low return?

And how much can that help the overall asset yield going forward, ex rates?

Yes.

Thanks, Ken.

Good question.

We're thinking that the key areas that we'll focus on would be in the areas of the consumer side.

You can see -- we mentioned this before that auto is a low-return business.

We like the auto business, but we're moderating the portion of the balance sheet that auto will take up going forward.

So you could see loan yields rising as a result of that.

On the commercial side, areas that we're looking at, as you may have heard in my remarks, includes, on an ongoing basis taking a look at the back book in C&I, which is a typical business as usual just kind of behavior.

But we think that, that can add benefit to the loan yields over time.

As well as in Asset Finance.

As we mentioned, we have some legacy assets that were put on during the RBS days in the larger-ticket area (inaudible).

So moderating our exposure there will also drive loan yields higher.

So I think we've got a lot of benefit going forward in balance sheet optimization, so we're optimistic that, that will provide lift, ex rates, in the future.

Ken, it's Bruce.

I'd just add to that I think what we're really seeking to do is put a little more program discipline.

I think we've been doing a good job of balance sheet optimization all along, but we're going to look for opportunities to shift the mix in consumer in particular and formalize that and have targets in place.

We'll look for pricing discipline across all portfolios.

John mentioned auto, but I think there's opportunities in elsewhere, in consumer and in commercial in particular, as we look at rollovers.

So we will have a program that allocates out responsibilities to specific individuals with targets that we monitor, much the way we run the TOP program.

Great.

Thanks for that color, Bruce.

And just a second question then.

How does that translate into earning asset growth?

I would presume that this will still net out -- even as you deemphasize some and grow others, that you'll still plan to net grow loans?

And can you help us just triangulate how that translates between loan growth and turning into earning asset growth?

This was the first quarter in a while where we saw flattening out on the earning asset growth side.

Yes.

And there, again, I think that the goal is to continue to achieve good levels, robust levels of earning asset growth going forward while we're making those re-mixing decisions.

I think we've done that pretty well all along.

I'd say the things that hit the numbers this quarter really was the aftermath of that late Q2 loan sale on commercial; and then some, I'd say, the stretched conditions that we saw in commercial.

We're not really going to push on a rope here.

If it's not there, we'll be disciplined.

But I think we saw, in September, things starting to tick up a bit.

And I think the sentiment in Washington, if we start to see the pro-growth agenda take place, that can also create, I think, more loan demand, which will ease some of the pressures that we're seeing on the commercial side.

I might flip it over to Don for some color there.

Yes.

I think that's exactly right, Bruce.

The other thing I'd mention is we did have a reasonably strong quarter in our bond businesses, which were reflected in a little bit of a reduction of our outstands from the utilization standpoint, particularly on Mid-corporate businesses.

So we picked up a little bit on the fee line while we saw a little bit of moderation in loan growth.

Our pipelines look pretty strong right now.

And I would just echo what Bruce said around terms and conditions.

It's very aggressive out there with everyone looking for loan growth.

So if transactions are getting too stretched from a terms or conditions or a pricing standpoint, we'll probably stand back and let that go away.

So that will be a moderating factor.

But as we look deeper into the fourth quarter and into next year and you begin to get some certainty around some policy coming out of Washington, we think that could be a quite a good backdrop for continued expansion of the business.

And then the last thing I'd say is we are seeing really good client growth in our expansion markets.

So while terms and conditions are tough, we're adding clients, and that should result in incremental demand as we go forward there.

And I'd just add to that.

I'll flip it to Brad, too, for some color.

But the other thing I'd point out, Ken, is that very consistent on our consumer side loan growth.

So we've been kind of in a 5.5%, 6% annualized growth rate every quarter, which we saw again this past quarter.

I think some of the reason we've been able to achieve that is we have unique spaces that were playing, such as the education refinance market, such as personal unsecured with our corporate partners.

And so we expect to continue to see opportunities to build on that.

And so that can inure us from any little dips that we see in overall consumer loan demand.

So Brad, maybe you can pick up with that.

Yes, Bruce.

I think you articulated it well.

We've got a unique space in student and unsecured.

We see plenty of runway for both of those to continue to grow.

We've had good growth in mortgage lending and we believe that, that will continue.

Really, what we're talking about in auto really shouldn't change the trend line because we've already been pulling back in auto.

In fact, you saw that key vendor release and we got out of the SCUSA relationship a couple -- the last quarters.

So I think there's plenty of reason to believe that the trends that we've seen up until now can continue.

Next question comes from the line of John Pancari of Evercore.

Also on the balance sheet side, I just wanted to talk a little bit about what you're seeing in terms of deposit competition.

And is there pressure to implement pricing programs to bring in deposits?

And also, what are you seeing right now as to where your deposit beta is trending and where you think it could move in coming quarters?

Yes.

I mean, why don't I start and flip it to John.

But I think the consumer side continues to be well behaved, and so I think we're continuing to see discipline hold throughout the market.

And the higher you get in the cycle, you start to see the betas rise.

But right now, they're still quite low.

On the commercial side, obviously, there's sophisticated companies there as you particularly get up into the bigger-sized companies.

They have treasurers and they're looking to participate.

As rates go up, they see the cost of the loans going up, so they want that cost on their funds that they're leaving with us to sort of reflect the rate rises.

And so I think we've done a good job of continuing to grow there and rotate out some of the higher-cost segments, like financial institutions and governments, and try to get more organic growth coming from corporates and in particular areas that we haven't really fished for deposits in, like commercial real estate, we're launching some new products like escrow deposits.

So I think overall, we're really pleased that we're tracking to our own models in terms of how things are going.

And the last thing I'll say is that we're also, even though we're paying up a little for these deposits, what we're doing with the funds in terms of the loan growth that we're funding, is very attractive.

So the areas that Brad just spoke about, at refi loans, the personal unsecured loans, have very good yields.

And so it continues to benefit us, these transactions at the margin.

If you look at matched funding of what's growing on the asset side, what's growing on the deposit side, those are very accretive and they're accretive to our NIM and they're accretive to our ROTCE.

So with that, why don't I pass it over to you, John.

Okay.

Yes.

Just getting into the deposit beta part of it.

You asked about where we are on there.

So on a cumulative basis through 3Q, total deposit beta would be 17%.

And in-quarter sequentially, it would 36% for the third quarter.

We would see that coming down a bit in the fourth quarter in part due to the fact the Fed's going to take a quarter off and gave here another quarter.

And also, it just gives us some breathing room to allow the deposit initiatives to really start to kick in.

And so on the consumer side, the investments that we're making in data and analytics and really refining our promotional approach; and on the commercial side, the investments that we're making in product offering and targeting with respect to the segments that are more deposit-rich.

So that kind of optimization going on, on the deposit side, along with [where we believe] that macro is coming out, we'll see betas -- in-quarter betas come down a bit in 4Q.

Okay.

John.

That's helpful.

And then separately on the credit side.

I know you saw your auto losses increase on a linked-quarter basis.

But there -- and I know you pointed to some seasonality there as well, but they're also up 14 basis points year-over-year.

So can you just talk about what you're seeing there in terms of auto losses and your outlook as we go forward?

Yes.

Let me start, Brad, and I'll flip to you.

But I'd say on a linked quarter, there's partly seasonality.

The other thing that we're seeing is a little bit of a kick up in -- related to our out-of-state or out-of-footprint state expansion initiatives that we commenced about 2 years ago.

And I think there might have been a little adverse selection there in a couple of states, and so those vintages are having slightly higher loss rates and that's burning its way through.

It's not anything that is significant.

We have, since when we've decided that we're going to start to run down the size of the auto portfolio, we've now exited those states.

And so it's limited to a fairly narrow period, vintage-wise.

But that's really, I think, the main thing that you're seeing there.

Brad, do you want to add to that?

You hit it.

The 2Q is seasonally low.

That is the typical seasonally low period, so that explains the quarterly increase.

And to your point, we've got a very isolated, it was related to out-of-footprint 2016 vintages.

We stopped those vintages right away.

And the other thing I would just point out was is, we said for quite some time, when we began to expand our credit from super prime to sort of mainstream prime, so we always expected a little bit of an increase.

And been very much in line with what we expected.

And we have given some guidance on consumer losses a quarter-plus ago, and we're riding (inaudible).

Yes.

So not something that we're -- it's tracking to what we expected...

Tracking to what we expected.

Exactly.

Okay.

And that out-of-footprint stuff, that -- attribute that -- point of the year-over-year pressure?

I'm sorry, you broke up there, John.

The year-over-year increase in auto losses, that's mainly coming from the out-of-footprint stuff?

Yes.

I think it's the 2. It's the out-of-footprint, plus the starting -- when we started mixing more prime in with the super prime, correct.

Got it.

And the size of that out-of-footprint book?

It's relatively small, and it's quite small and an overall basis.

And the vintage we're seeing the stress in, we stopped originating...

(inaudible) we spotted it.

Spotted it.

So it'll be an immaterial piece of the portfolio.

Next question comes from Brian Klock of Keefe, Bruyette, Woods.

Congratulations first on hitting the 10% return on tangible common equity target.

And I'll start with the good momentum you guys have had in the commercial bank and with the sort of retooling there.

A lot of your peers haven't posted positive C&I growth.

So maybe you can talk about what you're seeing there, what's helping contribute to your better-than-peer growth in the commercial book.

Yes.

Let me start and flip to Don, but I think there's a couple of things.

One is that we continue to add great coverage bankers as we've expanded geographically, brought in some really excellent bankers from some of our regional peers to head up those efforts.

And so as they build out their teams, it's natural that we're going to gain market share and they bring some of their relationships over to Citizens.

We added a new head of health care industry vertical as well.

So really, part of this is just we're playing offense, we're trying to expand the overall customer base, and that's allowing us to grow.

The other thing I'd say is that we've just focused on pockets where we do expect that there should be relatively more growth.

So some of the Mid-corporate, bigger-size companies, historically, we were a little bit under-scale there.

We were focused more on the Middle Market.

I think if you go back for maybe the 4 years I've been here, we've taken the Middle Market customer count from, say, 2,000 to close to 2,500.

But the Mid-corporates, the companies with revenues from $500 million to $2.5 billion, we've taken up from 450 to 750.

And those tend to be bigger credits overall.

So we've seen some nice growth there.

So this really, I think, reflective of the growth investments that we're making and then the focus that we have on particular industries and companies.

Don?

I think that's right.

And the discipline around client planning and market planning is at a totally different level than it was a few years ago.

So that is presenting a little bit of a tailwind to us.

And I think in addition to the bankers that we've hired, we vastly improved our product capabilities.

So the relevance that we are going to market with across the trading rooms, across the capital markets, across M&A now, it's resonating with the clients.

So we're still a relatively midsized bank, but we have world-class players.

And we're in our sweet spot, which is the Middle Market in the low end of the larger companies.

We've just got great bankers out in front of these clients, and it's terrific traction.

So we're very pleased with the progress we've made.

And as Bruce said, we've added probably 40 bankers in our expansion markets over the last 1.5 quarters, and they are from really strong local banks, SunTrust and U.S. Bank and JPMorgan in the various markets.

And they're bringing clients with them.

And we're already winning business because of their relationships, so it's very encouraging.

Thanks for that color.

And then just a follow-up.

On the consumer side, you mentioned earlier, Bruce, the good growth from the investments you've made there, and obviously, the education book is growing pretty well, very strong.

Maybe you can -- you or Brad, can kind of give us the break out in that education book, of how much has come from your core refinance product in school and your relationship with SoFi.

I'll steer that directly to Brad.

Yes.

So there was couple of [events] to that.

But if you let me answer from the standpoint of originations in the third quarter.

So the third quarter originations, about 10% of our student originations came from purchasing the SoFi loans.

About 60% of our book came from the -- 55% or so came from our own organic originations.

And then the remainder are from ed refi, yes.

And then the remainder from the in-school product.

So it was about 90% of our book was, in the third quarter, was organic originations.

And our next question comes from the line of Ken Zerbe with Morgan Stanley.

In terms of -- let's assume that the market -- or we don't get the rate hikes that the market expects, right?

If we look at just simply the remixing of your assets into the higher-yielding asset classes, but also so that I'm assuming a natural upward pricing in deposit betas or on deposit costs, can you get NIM expansion just from those 2 pieces without higher rates?

Yes.

I think -- and I'll flip to you, John.

But I think if you look at the year-on-year growth in the NIM of 21 basis points, about half of that was self-help and then the other half was really due to rates.

If rates didn't move higher, I think you'd have less pressure on your deposit cost, for sure.

So I'm not sure you'd be getting the squeeze there.

You think it would be that what we saw when we were lower for longer, I think, there's an opportunity cost of the asset-sensitive position in no rate hikes.

But there's general stability in that environment, so it puts the onus back on us to keep remixing and being disciplined around pricing and some of the things we talked about earlier in the call around balance sheet optimization, which I think can still help us get some NIM lift.

So John, you want to add to that?

Yes, not -- well said.

I think the -- one way to think about it is that we're still on business accrete, business exit perspective of about, call it, 15 basis points below the median of our normally situated peers.

And so without rates moving, we feel like we're in -- we've made a lot of progress on balance sheet optimization.

We feel like we can make a big dent in closing that gap.

Just like we're doing on the profitability side, top of the house, in ROTCE, we're going to be closing the gap on the NIM side as well.

And that doesn't depend on rates, given what you heard, Bruce, in terms of mix shifts alone drove about half of our benefits year-over-year.

All right.

Great.

And just staying with the deposit side -- or sorry, the funding side.

I saw you use some cash to pay down a bit of FHLB this quarter.

Are you done with most of sort of the, I might say, restructuring of the deposit side, such that we're at a good point between wholesale borrowings and core deposits?

Or is there more to go?

Yes.

I think we were about where were comfortable to be with -- we look at.

I think we're in the neighborhood of $14 billion or so of borrowings.

That should be about stable going forward.

You think about that in terms of generally wholesale borrowings, funding, security portfolio.

So when you look at the whole balance sheet, we're in kind of about the right spot.

And so we don't expect to see big changes in that going forward.

And your next question comes from the line of Peter Winter, Wedbush Securities.

On the fee income side, the outlook for the fourth quarter is kind of stable.

I'm just thinking, looking out in 2018, where you see some of the biggest opportunities from the fee income side?

And then secondly, any thought about fee income acquisitions to enhance some of that growth?

Okay.

I'll start as usual and then maybe flip to John for some additional color.

But I think the positioning we have on the commercial side is quite strong across everything we're doing.

So our Capital Markets capability, the purchase of the M&A capabilities with Western Reserve and integration and ability to start creating more leverage and more flow opportunities for them.

And I think we have opportunities just to continue to expand capabilities, push into things like securitization or some other initiatives that we have.

So everything off the Capital Markets platform, provided that the market conditions stay favorable, I think we can continue to see growth there.

I do think on the global markets, which is our [FX] and interest rate risk management platform, that we are still scratching the surface.

We used to be on RBS's platforms, we've migrated to our own platform, so we, I think, have a much broader capability in terms of product.

And then also, we've up-tiered the quality of our team, so we have, I think, more intellectual capital and ability to show good ideas to our customer base.

So I see nice upside there.

And then on our cash management business, we've also upscaled our capabilities.

We're working through a re-platforming of the business that will, I think, put to us right up there with the top-sized banks in terms of capabilities.

And that will be implemented late in 2018.

So I'd see some potential for momentum there.

So feeling good about what we've accomplished so far in commercial, and I think we're positioned for further growth.

On the consumer side, it's been a little tougher sledding.

One of the things we've invested heavily in is our wealth management capabilities.

We see really lots of potential there, untapped opportunity, and I think we have the business positioned very well to start to gain further tractions and have that show up in the numbers.

I think at this point, we're kind of expanding the relationships that we have inside the branch of business, but we're moving more towards a mix of managed money as opposed to what we did historically, which was more transaction-based sales and annuity-type products.

I think that's great for the customers and it's great for us in the long term, but it creates a near-term revenue headwind, which the lines haven't really crossed yet.

So we've been building up our managed money book, that's creating, I think, more of a annuity-type revenue stream going forward.

But that's resulted in the business being somewhat flattish over the past 6 quarters or so.

I expect we'll start to see that break out, and we should see growth there in 2018.

And then the mortgage business has been -- we've done some very good things and putting a good foundation in place.

Our servicing and fulfillment capabilities are amongst the best rated by J.D. Powers consistently, and that wasn't the case a couple of years ago.

But we still have to, I think, hone the model to get more conforming loan officers that are better integrated into the branches and build some additional capabilities direct-to-consumer, potentially enter into the correspondent business.

So there's more work to do there, but ultimately, there'll be revenue upside there as we get that right.

So that's kind of a long-winded answer.

I don't know if there's any additional color, John, they want to add to that.

(inaudible) and I think you hit it.

We're making investments across these 4 or 5 businesses.

And I think with Capital Markets, you've seen some break out.

But I don't think we'd call any of these businesses fully matured.

And I think that's the forward-looking, meanwhile needle on deposit fund raising (inaudible).

Anything from Don or Brad?

No, I think you've covered it.

The only thing I would add is I think on the mortgage side, in terms of the opportunity to continue to grow fees, winning more scale, you talk about possibly getting into the correspondent business, maybe acquisition.

And then as far as getting more scale and a very good servicing operation that we have, is a real opportunity for us.

Yes.

Great.

And then the last part, you said potentially more acquisitions.

I think yes, I think we will look to do smart bolt-on acquisitions potentially in the areas that we just talked about if it can get us farther down the track faster, I like to say.

So like with the M&A boutique, Western Reserve that we did in 2017, that took us from roughly 6 M&A bankers to 36 M&A bankers, which, given the sized client base we have, is where we need to be.

We potentially still can scale up, I think, and serve our customers well.

But if there's things we find in wealth or Capital Markets or the payments space that makes sense to us, we're going to start having the periscope out and start to look at things.

But again, I think they'll be very digestible from a size standpoint.

They won't knock us off our game in terms of capital return.

And so I think they will just be things that we feel makes sense, they're down the fairway, they fit and they can help address the need to get up that fee percentage and do more for customer base.

And your next question comes from the line of Vivek Juneja of JPMorgan.

A question on your consumer loans, the loans to -- for financing iPhones and Vivint, et cetera.

Can you give some color on how that's doing?

It seems like we've continued to see growth there.

Which of those products are you seeing more of it?

And also, some color on credit performance you've seen since you started this several quarters ago now?

Yes.

I'll take that one.

We're very pleased with the programs.

Continue to go very well in both the Apple program and the Vivint program.

Are growing for us.

They've been very good partners.

We do have other similar type of retailers and merchants coming to us asking us to work with them on building programs for them.

So we certainly think that there's upside.

The credit performance has been very good and in line with our expectation, and I'll just throw out a reminder that all the programs that we've entered into up until now have a degree of risk-sharing, so that even makes the credit performance more stable on those programs.

So all in all, we're very bullish on that as a business opportunity.

And your next question comes from the line of Geoffrey Elliott of Autonomous Research.

First, just a little clarification.

On the NIM outlook, the broadly stable is the base for that 3.05%?

Or is the base 3.05% excluding the commercial loan recoveries, so 3.03%?

It's the 3.05%.

Great.

And then I remember back at the time of the IPO, you had the mid-term 10% ROTCE target and then you also had a longer-term target and I think you had some charts pointing to something more in the 12% range for that.

I guess the question would be, you've got the 10% this quarter.

How long do you think long term is now?

Well, I think the 10% we've billed those as our medium-term IPO-based targets.

And I think what we have said all along is let us achieve those targets before we raise the bar.

It feels great to work hard and execute well and hit those targets.

And I think we will.

As we work on our budget for next year and up-freshen our strategic plan, you could expect us at some point next year to give you some additional targets that would be higher than where we are today.

So as I said in my opening remarks, that I do think what's gotten us this far, what's taken us from 4% to 10% is still pretty much the crux of how we want to operate the business.

We want to be disciplined on expenses, try to find efficiencies so we can fund our growth.

And in investments, have a very strong capital position so we can continue to grow the balance sheet and bring new customers to the bank.

We're investing in the fee businesses and we should start to see increasing traction through deeper customer relationships.

So everything that's taken us from 4% to 10% should be able to continue to propel us higher as long as we stay really disciplined and execute really well.

So stay tuned, and we'll, I think, have a comparable set of targets that we would move higher.

And that will be some time in 2018, we'll reveal that.

And your next question comes from the line of Matt O'Connor off Deutsche Bank.

Most of my questions have been answered, but just on the tax rate.

What should we think about for 2018?

Obviously some noise in the fourth quarter that you alluded to, but what's a good run rate?

I know there've been efforts with TOP to lower that in general.

Yes.

I'd say -- I'll start.

And John, if you want to add color.

But if you look at the underlying rate for the year, take out the noise of some recoveries in Q1 and this historic credit matter in Q4, then we're about 32.25%.

There's a constant tension between the growth in net income that we have and then the planning that we can actually do to knock the rate down from what the statutory rates are.

So we will continue to work through that.

We'll give you guidance on that in January when we have our year-end call and give our outlook for 2018.

But those are really the dynamics, as we have income growth which comes through at the higher fully effective rates and then we have to figure out plans like low income housing and other federal credit programs that we invest in, can we continue to lock the rate in around 32%, which is where it is now.

Obviously, the wild card in all of this is, is there corporate tax reform?

And we'd be a big beneficiary of that, staying that 32% rate clearly would increase our after-tax cash flow and our EPS and ROTCE and all those measures by a significant amount.

So certainly, I think there's broader benefits to the economy from getting a tax reform and tax cut package in place.

But there's specific benefits to regional banks and to us in particular, given our high tax rate.

And that also may knock out some of the programs.

But right now, I think the scuttlebutt is that the low income housing would be continued, but many of the other programs around energy or around historical tax credits, the drawbridge will be up and they will the grandfathered, but you won't be able to continue with some of those programs.

But there would really be less need to do those kind of investments if the rate is lower in the first place.

So John, anything to add on that?

Yes.

Just to add that -- so our tax rate being in the neighborhood of 32%, there's the tension that Bruce indicated.

I think part of the reason for that is that we're underpenetrated in tax-advantaged investment and the tax credit opportunities that many of our peers has availed of themselves of over many, many years.

So we got started a little bit later and we're catching up.

And we'll catch up over time and continued to invest in those programs.

So -- but you'll see that offset of earnings growth being offset by a ramp on catching up to the pack in the tax-advantaged areas.

And due to time constraints, we will turn the call back over to Mr. Van Saun at this time.

Okay.

Actually, we could go -- if there's a few more people on the queue, we could take in 2 or 3 more, Justin.

Sure, we do have some more questions here in queue for you.

Next, we'll go to the line of Marty Mosby of Vining Sparks.

Well, saved by the bell there.

I want to ask you about when you look at the increase in your loan yields, 75 basis point increase with 75 basis points increase in the Fed funds rates, so again, almost 100% beta on your asset side.

Now some of that's related to just being asset-sensitive and some of that's related to the balance sheet optimization.

But there's a strategic decision ahead of the company, which is when do you begin to think about neutralizing some of your asset sensitivity?

So just wanted to get a feel for how you're thinking about and tackling that strategic decision that's in front of you.

Sure.

So what we've seen over time is that we manage that in a -- let's just talk about the gradual rate rise scenario up to 100.

We've been in a 6% to 7% benefit position from that scenario.

That's, over time, come down to around 5.5%, and it happened naturally.

Just as rates start to rise, you start to roll down.

I still think that, that positioning to stay asset sensitive if we're in the early part of the rate lift cycle is a sensible place to be.

Because we have a coiled spring that releases and -- every time that the Fed continues to move and rates continues to go higher.

And I don't think that cycle is through yet, so we'll stay asset-sensitive, we'll glide down, and that's how we're planning to manage it.

I think it's too early to go but put on a big hedge and try to capture the additional income because I think you'll give up a fair amount of your upside.

John, anything to add?

No.

I think you hit it well.

Nothing further to add.

And then you mentioned your loan-to-deposit ratio as one of the things you're really guiding towards.

Is that because you like that is a constrain in liquidity?

Or do you look at more of the liquidity coverage ratio as the way you're managing liquidity on a tactical basis?

Yes, I think you hit it there.

I mean, we started -- the liquidity coverage ratio is basically how we look at this, and I think that's a much more sensitive measurement of what our liquid asset position is versus what deposit outflows could be in (inaudible) being stressed.

So it's a much more reliable measure.

And we have strong LCR ratio.

The LDR is more of an output of that, but nevertheless, it is a helpful measure to report (inaudible).

It's easy to calculate, it's right off the balance sheet.

So we look at both, but the primary measure really is the LCR.

So no reason to think there's any constraints from a liquidity standpoint in the near term.

Well, no.

I mean, we manage all of our resources as if they're constrained, right?

I mean so capital liquidity, et cetera, when we balance our liquidity so (inaudible) depends to what our opportunities are on the asset side.

And so we're seeing nice flows on the deposit side.

We had 2% growth in deposits this quarter, which is at the high end of our peers.

So we're feeling pretty good about our ability to fund our growth going forward.

Yes.

And the LCR is well above the minimum, so feeling quite good about where the liquidity and funding position sits today.

And your next question comes from the line of Kevin Barker of Piper Jaffray.

Could you talk about the credit performance that you're seeing within the student loan portfolio from the 10% of originations from SoFi and the 55% organic?

And then also the in-school product that you also mentioned.

Yes.

They're all performing extremely well.

We monitor it very, very closely.

And as you would fully expect, we look at each individual vintage, look at the emergence of the loss curves for each individual vintage.

And each and every vintage of those portfolios is performing right in line with the expectation that we have, and in some cases, better.

So we don't see any stress in those portfolios.

Keep in mind that we play very much in the super prime space as it relates to those products.

So we have average Ficos in the 780 range or/and above for all of our originations.

So these are very high credit quality loans, and we're improving the credit flow with our -- or the cash flow of the borrowers with the refi product, so they're performing extremely well.

And then a quick follow-up on some of the deposit conversation.

Are you seeing deposit betas accelerate in certain markets more than others, specifically in the Northeast versus some of your Midwest branches?

Deposit betas.

Is there geographical disparity in that?

There is a little bit.

I mean, we certainly see some competition, some difference in competition and in terms of what are the lead rates are for money markets and CDs.

There's a geographic mix to that.

But beyond that, no measurable difference in bank betas by geography.

Yes.

Nothing large-scale to date.

And as Brad mentioned, maybe a bit more frothy in the CD area, where they're seeing it -- seeing some (inaudible).

But not as much in money market.

So cost of funds impact is one of it...

Okay, Justin, we probably have time for one more.

Certainly.

Our last question comes from the line of David Eads of UBS.

Going back to the balance sheet, there was about a little over $0.5 billion increase in the other loans held for sale category.

(inaudible) is that agency mortgages?

Or is that some other sort of loan portfolio that's being positioned for sale?

And I guess just kind of on the mortgage side, you're talking about repositioning that business.

Should we expect the amount to be held on the balance sheet, the pace of growth on the balance sheet to slow?

Or is that really, okay, you're going to try to keep the non-agency business going about the same pace and just accelerating the pace of the agency business?

Yes.

I'll try to jump in on that and others can add in.

So in the other, what Citizen's held for sale is the mortgage stuff, but it's also loans that are pending in syndications.

So you'll see both of that driving the held-for-sale category.

And so they're both drivers, and we've had flow in both of those areas that would increase the held-for-sale numbers at the end of September, in particular, the syndication volume that is yet to be sold down.

On the mortgage front, yes, I mean, I think we're looking to remix our off-balance sheet leverage if you will, in terms of non -- in terms of conforming piece.

But the nonconforming is still a good product for us.

We're seeing good risk-adjusted returns there.

They drive customers into the bank.

Those customers are candidates for the deposit products and then maybe are actually existing customers of the bank that we're serving, and they're also candidates for other (inaudible) and et cetera.

So we're looking to drive both of those.

And the off-balance sheet conforming piece won't come at the sacrifice of the nonconforming piece.

Okay.

Any color, Brad or...

No.

I think John said it exactly right.

We're looking for really just acceleration of the nonconforming piece.

I'm sorry.

(inaudible).

Sorry.

Yes.

Okay.

Well, why don't I just wrap up the call here by thanking you once again for dialing in today.

We truly appreciate your interest.

It's really gratifying to hit our milestones this quarter, though that we're going to continue to stay focused on the work in front of us yet to come to build a great bank and to do even better.

So thank you and have a great day.

That now concludes today's conference call.

We thank you for your participation, and you may now disconnect.