Citizens Financial Group Inc (CFG) 2017 Q4 法說會逐字稿

Good morning, everyone, and welcome to the Citizens Financial Group Fourth Quarter and Full Year 2017 Earnings Conference Call. My name is Brad, and I'll be your operator today. (Operator Instructions) As a reminder, this event is being recorded.

Now I'll turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.

Hi, thanks, Brad. Good morning, everyone. We really appreciate you joining us this morning. We know it's a busy day.

We've got a lot of really positive ground to cover. Our Chairman and CEO, Bruce Van Saun; and CFO, John Woods will review our results and provide an update on our financial targets. And then, we're going to open up the call for questions. Also joining us today in the room are Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking.

And of course, our lawyers want me to remind everyone that in addition to today's press release, we've also provided a presentation and financial supplement, and these materials are available at investor.citizensbank.com, and our comments today will include forward-looking statements, which are subject to risks and uncertainties. We provide information about the factors that may cause our results to differ materially from expectations in our SEC filings, including the 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 with that, I'm going to hand it over to Bruce.

Okay. Thanks, Ellen. Good morning, everyone, and thanks for joining our call today. We're pleased to report 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 each and every day. We're taking good care of our customers, and we entered 2018 with some nice momentum.

The highlights of the quarter, from my perspective, were the continued delivery of good top line growth with 8% year-on-year underlying revenue growth as well as robust positive operating leverage of 6.4%. For the full year, underlying revenue growth was 10%, and the operating leverage was 6.8%. The commitment to positive operating leverage has powered improvement in our key metrics. Our underlying ROTCE hit 10.4% in Q4, and our efficiency ratio improved to 58.5%.

Our success in hitting our medium-term IPO financial targets has led to our establishment of new medium-term targets, which we will cover in some detail later in the call. Suffice it to say, we believe we have a good plan and a good leadership team that is executing well across the board, giving us confidence in our outlook.

We continued to delivered well on our strategic initiatives, and we continue to do more and better for our key stakeholders, for our customers, our colleagues and the communities that we serve. We remain focused on raising our capital return to shareholders. We announced an increase in our Q1 dividend of 22% to $0.22 per share, and we returned $424 million to shareholders in Q4 from both dividends and share repurchases.

As we look to 2018, we expect our agenda to be largely consistent with 2017. We are hopeful that the macro environment will deliver some tailwinds given the recent tax legislation, faster economic growth, a path to higher short rates and regulatory reform. But as always, our focus will be on execution and the things that we can control.

So with that, let me turn it over to our CFO, John Woods, who will take you through the numbers in more detail and provide you with some color. John?

Thanks, Bruce. Good morning, everyone.

Let's get started with our fourth quarter results, which start on Page 4. As Bruce mentioned, our reported results reflect the impact of tax reform and other notable items that we've detailed on Page 5 of the earnings presentation. Including these items, we generated net income of $666 million, EPS of $1.35 and a return on tangible common equity of nearly 20% for the fourth quarter. For the full year, including the notable items detailed on Page 37, we delivered net income to common of $1.6 billion, EPS of $3.25 and ROTCE of over 12%. Excluding the notable items, underlying fourth quarter results were very strong. ROTCE was 10.4%, net income to common of $349 million was up 24%, while EPS was up 29% year-on-year. And we delivered positive operating leverage of 6.4%, with strong NII and fee income results across our businesses, which drove the improvement in our efficiency ratio to 58.5% for the quarter.

Overall credit quality continues to be excellent, with nonperforming loans coming down to 79 basis points of loans. We continue to actively manage our capital base, with a 7% year-over-year increase in our tangible book value per share to $27.48 and a robust year-end CET1 ratio of 11.1%.

We are focused on shareholder returns and pay out $1.1 billion to common shareholders through higher dividend and share repurchases. That's up 70% from 2016. And we continue our positive trajectory with a 22% increase in our quarterly common dividend that we announced today.

Moving to Page 5. Let me cover the notable items in the quarter. Given the tax legislation in December, we revalued our net deferred tax liability and recorded a onetime tax benefit of $331 million. We utilized $22.5 million to invest in our colleagues and the communities we serve. All in, these items contributed $318 million to net income and $0.64 to EPS this quarter. In addition, in connection with our continued balance sheet optimization program, we completed the sale of a $67 million TDR portfolio of home equity and mortgage loans at a pretax net gain of $17 million. We utilized those proceeds to cover TOP IV initiative costs.

On Page 7, we present our fourth quarter results excluding these items. As you can see, we continue to deliver strong results, with net income to common of $349 million, up 2%; and EPS up 4% linked quarter. We continue to deliver on operating leverage, which came in at 6.4% year-over-year, with revenue growth close to 8% and expense growth less than 2%. We posted another strong quarter from a return perspective, with ROTCE of 10.4%, up 200 basis points year-over-year. Our efficiency ratio was 58.5%, an improvement of 3.7 percentage points. Both of these metrics are well ahead of our medium-term IPO targets. These strong results reflect continued execution against our strategic initiatives and our commitment to focus on continuous improvement to drive further revenue growth while maintaining operating expense discipline.

On Page 9, for the full year, we delivered underlying EPS growth of 34%, with positive operating leverage of 6.8%. Also, we grew our balance sheet nicely. Notwithstanding an increasingly competitive environment, average loans were up 6%. At the same time, we expanded our net interest margin by 16 basis points. We are also seeing a solid return on the investments in our fee businesses as underlying noninterest income was up 7% in 2017.

Taking a deeper look into NII and NIM on Pages 10 and 11. We continue to deliver attractive and disciplined balance sheet growth, which helped us drive a 2% linked-quarter increase in NII. Net interest margin improved 3 basis points linked quarter and 18 basis points year-over-year, which reflects a nice improvement in loan yields and better results in deposits, given the benefit of our balance sheet optimization efforts and a more constructive rate environment.

On a linked-quarter basis, retail and commercial loan yields were each up 5 basis points. Partially offsetting the higher loan yield, deposit costs were higher by 2 basis points, reflecting the rise in short rates. Total average deposits increased 1% from the prior quarter, driven primarily by growth in demand and term deposits. Period-end deposits were up 2%, with increases across most categories.

Turning to fees on Page 12. On an underlying basis, noninterest income increased 2% linked quarter, largely reflecting strength in FX and interest rate products and trust and investment services fees, along with positive results in mortgage banking and letter of credit and loan fees. These growth areas were partially offset by lower capital markets fees, which were still strong but came off the record levels we've delivered the past couple of quarters.

Year-over-year, our noninterest income was up 3%, driven by strength in the capital markets business given our expanded capabilities, higher trust and investment services fees given improved sales productivity and fee-based sales results.

Card fees were also better given higher purchase volumes, along with the benefit of the first quarter revision of contract terms for core processing fees. While mortgage banking fees were down, driven by a decline in servicing fees with relatively stable production fee income, our origination volumes outperformed.

Turning to expenses on Page 13. On an underlying basis, expenses were stable compared to the third quarter. Lower salaries and employee benefits and other operating expenses were offset by an increase in outside services, which include costs related to our strategic growth initiatives.

Year-on-year, our expenses were up 1% as salaries and benefits expense was higher, reflecting the impact of strategic hiring, merit increases and higher revenue-based incentives. 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 the lower-value areas in order to continue to self-fund our growth initiatives and enhance capabilities to serve customers. Continuous improvement is part of our DNA, and we continue 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 Page 14, you can see we continued to grow our balance sheet and expand our NIM. Overall, average loans were up 1% on a linked-quarter basis and 4% year-over-year. In consumer, we grew the portfolio 5% year-over-year, with continued expansion in residential mortgages and higher risk-adjusted return categories, like 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.

As you know, we have been reducing the size of our auto portfolio, and that should continue over time. As a result of these efforts, in addition to higher rates, we've expanded consumer portfolio yields by 5 basis points in the quarter and 38 basis points year-over-year.

We also saw nice growth in commercial, with average loans increasing 3% year-over-year, where we continue to execute well in Mid-corporate and Private Equity, Commercial Real Estate 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 in cross-sell; and in Asset Finance, where we had historically focused on big-ticket leases given RBS ownership. Our overall goal in Commercial is to raise returns and build strong relationships while still achieving good loan growth.

The net results in Commercial reflect a 7 basis point improvement in yields linked quarter and a 70 basis point increase year-over-year, reflecting the benefit of higher rates and optimization efforts. Also, Citizens remains well positioned to capitalize on the rising rate environment, with our asset sensitivity relatively unchanged at 5.1%.

On Page 17, looking at the funding side. We saw a 2 basis point sequential quarter increase in our cost of deposits, reflecting the impact of higher rates but also good discipline and progress on initiatives. We continue to find attractive balance sheet growth at accretive risk-adjusted returns, which is driving NIM higher in spite of these gradually rising deposit costs. Our overall funding costs were also up 2 basis points sequentially.

Year-over-year, our cost of funds was up 21 basis points, reflecting deposit cost increase of 17 basis points as well as a shift to more long-term funding. This compares with overall asset yield expansion of 39 basis points.

Our deposit betas remain in line with our overall expectations given where we are in the rate cycle. And we feel good about our ability to execute against our optimization strategies and become more effective in our future deposit gathering.

Next, let's move to Page 18 and cover credit. Overall, credit quality continues to be excellent, reflecting the ongoing mix shift towards high-quality, lower-risk retail loans and a relatively clean position in the commercial book. The nonperforming loan ratio improved 6 basis points versus the prior quarter to 79 basis points of loans this quarter, while improving 18 basis points from the year ago quarter.

The net charge-off rate increased to 28 basis points from 24 basis points in the third quarter, given seasonal impacts and the maturing of our portfolio. Our commercial net charge-offs were very low again this quarter, while retail net charge-offs were $11 million higher than the third quarter, in part due to higher seasonality in auto and education and a modest reduction in recoveries.

Provision for credit losses of $83 million was $5 million above charge-offs. The provision was up $11 million compared to a relatively low level in the third quarter and down $19 million versus a year ago, reflecting improvement in overall credit quality.

Lastly, our allowance to total loans and leases ratio was relatively stable at 1.12%, and our NPL coverage ratio improved to 142% from 131% in the third quarter and 118% in the year ago quarter.

On Page 19, you can see that we continue to maintain robust capital and liquidity positions. We ended the quarter with a CET1 ratio of 11.1% or 11.2% when incorporating the benefit of a proposed FASB accounting standard tied to the recent tax legislation. We ended the year with a CET1 ratio above guidance, given our strong fourth quarter performance, lower risk-weighted assets and the impact of the tax legislation.

This quarter, we repurchased 8.8 million shares and returned $424 million to common shareholders, including dividends. As expected, our board approved a 22% increase in the quarterly dividend to $0.22 a share.

On Page 20, we continue to provide color on how we are progressing against our strategic initiatives. Suffice it to say, we are executing well overall, and we'll continue to make adjustments as needed.

Page 21 provides some detail on our TOP IV initiatives. The TOP programs have successfully delivered efficiencies that have allowed us to self-fund investments to improve our platforms and product offerings. We have largely completed the TOP III program, which launched in mid-2016, and we estimate that it has delivered run-rate benefits of over $115 million as of the end of 2017. Our new TOP IV programs is going very well, and we are on track to deliver another $95 million to $110 million of pretax run rate benefits by the end of 2018.

On Page 22, you can see the steady and impressive progress we are making in improving our performance. Since 3Q '13, our ROTCE has improved from 4.3% to 10.4%, and our underlying efficiency ratio has improved from 68% to 58.5%. Our EPS continues on a very strong trajectory as well, with a CAGR of nearly 30% over the past 4 years to $0.71 from $0.26. While we are pleased with this performance, we still have opportunity for further improvement, which we will cover shortly.

On Page 23, we review our full year performance against the guidance we provided at the start of 2017. You can see the green [ticks] on the right column demonstrating another year of strong execution.

On Pages 24 and 25, we detail our guidance for 2018. Quite similar to 2017, with good top line growth, a 3% to 5% positive operating leverage target, further efficiency ratio improvement and capital normalization.

Let me add a few points of color. We are expecting slightly slower loan growth overall given competitive market conditions but still in the range of 4.5% to 5.5%. Growth will be focused in the areas we believe offer attractive risk-adjusted returns. We should see strong NIM improvement in the range of 9 to 12 basis points, which reflects market expectations for rate hikes in April and October as well as continued execution on our balance sheet optimization efforts. We expect continued growth in noninterest income in the 4.5% to 6% range as we leverage our investments in expanded capabilities and continue to invest for the future. We expect credit quality to remain well controlled as our charge-offs are -- gradually normalize and some growth in provision will be needed for loan growth. We expect our LDR to be about 98%, and CET1 at the end of the year between 10.6% and 10.8%, with a dividend payout ratio of around 30%. This payout ratio would be higher but for the first half impact of tax legislation and the timing of CCAR.

Next, let's turn to our fourth quarter (sic) [first quarter] outlook on Page 26. This is typically a seasonally softer quarter for us given several factors, including day count, seasonal activity levels and elevated FICA taxes. We expect loan growth to come in at about 1%, and we should see about a 5 basis point improvement in NIM for the quarter. We are expecting our effective tax rate to come in at about 23%, including a small historic tax credit impact. We also pay our preferred stock dividend in the first and third quarter each year. Overall, our view for the quarter reflects continued strong execution against our plan.

And with that, let me turn things back over to Bruce.

Thanks, John, and I think you meant the first quarter there. You said the fourth, but I think everybody knew what you were talking about.

Yes.

So let's turn to Page 27, and let's focus on where we're taking Citizens over the medium term. We have a mission to really make a difference for our customers, colleagues and communities so that they can reach their potential. Banks that can focus on and deliver this will build long-term franchise value and stand out in a crowded banking landscape. We aim to become a top-performing, widely admired bank. To get there, we'll rely on our customer-centric culture, our mindset of continuous improvement and building excellent capabilities. And our credo informs and guides our culture and behaviors. This mission, vision and credo really resonates with our stakeholders and is a key foundation of our past success and is an important reason I am confident in our future outlook.

On Page 28, let me identify some of the keys to taking our financial performance to the next level. The good news is that we believe there's plenty more for us to do to drive improved performance. We have plenty of fuel left in the tank, so to speak. I'll highlight a couple of things here on this page.

First, we believe that our commitment to continuous improvement through execution of TOP programs and BSO is differentiating and will drive continued outperformance versus peers.

Second, we are excited about the opportunities to leverage the investments that we've made in our fee-based businesses over the last few years. I think overall, we have a tremendous opportunity to continue investing to build up these businesses and to realize the revenue potential in our franchise.

And lastly, prudent capital management and balance sheet rate positioning will continue to help drive improving returns.

On Page 29, we unveil our new medium-term financial targets. You can see that we've outlined our expectations for the overall economic environment, which is relatively constructive, particularly given the recent tax legislation. Over the medium term, we expect to deliver continued improvement in ROTCE, moving to 13% to 15%, including the benefit from the recent tax legislation. We expect a rising rate environment to be helpful in reaching our targets as we are factoring in that short rates will increase,, on average, a little over 2 times per year given the current rate curve. We expect to deliver solid top line growth while driving annual positive operating leverage in the range of 3% to 5%. This should lead to continued efficiency ratio improvement down to 52% to 56%. And we also expect to see some normalization in credit from the excellent performance that we're seeing today. And we continue to be focused on returning capital to shareholders through our repurchase program and targeting a dividend payout of 35% to 40%. Over this time frame, we would expect to reduce our CET1 ratio by approximately 30 to 40 basis points annually to a target of around 10%.

As we did with the original ROTCE walk, we've presented an updated version with the road map of how we think we can go from roughly 10% today to 14% on a full year basis, give or take, with time.

So to sum up, Page 30, we feel that we've delivered strong results in Q4 and for full year 2017. We will maintain our mindset of continuous improvement in 2018, and we will look to drive more top and BSO program benefits. We feel our balance sheet, capital and credit position remain robust. And as we head into 2018, we feel very good about our ability to grow the business and drive towards our new targets. We are making good steady progress across the board as we aim to become a top-performing bank.

So with that, operator -- Brad, let's open it up for some questions.

(Operator Instructions) And we go to the line of John Pancari with Evercore.

Just on the tax side, I just wanted to get your updated thoughts in terms of the benefit of tax reform. As you look at your expense base and as you look at your investments, I know you've got the TOP IV plan and the programs very much in place. How much of that tax benefit do you think, longer term, ends up accreting to the bottom line? And sorry if you already alluded to that. And then separately, what areas in terms of technology spend are you putting new money to work?

Sure. So I think, certainly in the near term, most of that tax benefit flows through. We announced at the end of the year, the bonus program for certain employees here, and a contribution to the community foundation that we run, which I think was the right thing to do. We're looking at our overall technology spend, I think we've been funding that at a very good clip. So at the margin, we might try to get a few more things through a little faster, but I think that's really at the margin. So I think that, in terms of our own spend, we're going to mainly let it flow through. I think the question over time is, what happens in the marketplace? Do some of our peers -- we don't intend to lead on this, but do some folks offer a little bit back and get more aggressive on loan terms, for example, that takes the market to a different place than it is today? I don't anticipate that happening in the near term, but we'll see how that plays out over time. So we're optimistic that there should be a pretty good benefit that we get to produce in 2018 from the overall tax reform. And I think that should be pretty well sustainable in our view. Although over time, you might see a little bit of it competed away. Just in terms of where we're spending money, one of the things that we've been pleased with is we've said that for much of the last 5 years, we were playing catch-up in terms of our technology spend and freshening our application suite and the infrastructure that we run. We've now, moving to the good news, having been largely caught up, we can focus on playing "offense." And so there's a lot more funding going into things like digital, some of the origination and fulfillment platforms that'll create efficiencies and better customer experiences. So I'd say that's really where the future spend is going.

Okay, great. And then, on the medium-term targets, the ROE outlook and the efficiency ratio, I mean, in terms of a medium term, how do you define that time frame? Just want to get a little bit of clarity around that. And then, what type of rate environment does the -- do those medium-term targets assume?

Yes. So I think the medium term, we're being, I think, just a little less specific than we were during the IPO walk when we kind of laid it out and said it was 3 years and we hoped to get the 10% by Q4 of '16. It actually took us 3 quarters more to do that. We executed the plan well, but we didn't get the lift in rates that we had anticipated. So I think the -- our view now is to be a little less specific, just call it medium term. But I'd still think, you kind of think in terms of 3-year cycles. And so I'd say it's fundamentally, roughly, a 3-year view, plus or minus, depending on what happens in the environment. Again, one of the keys will be what happens with rates over that period. You can see on the walk on the page that that's still -- we have an asset-sensitive position. We still expect to get a benefit from that. If we look at triage among dot plots, consensus estimates, forward curve, we come up with an expectation right now that we should see 2 rate hikes per year for the next 3 years. That includes '18, '19 and '20. So that's built into the forecast here. One of the things I will point out is, notwithstanding we had far fewer hikes than what we assumed when we put the IPO targets out, we found other ways to compensate. We got more positive operating leverage than we anticipated. So we're not sitting here reliant on the rates, but they certainly would create a tailwind if that scenario develops.

Okay. And then, one last thing. If you do get that type of move at the short end but not much follow-through at the longer end and you get a flattish curve throughout this period, does that take away much? Or are you still able to offset that?

It takes away some. So John, you could add here, but I think we don't anticipate a full parallel shift. But if we really had a pure flattening of the curve, that would take away a percentage of the benefit.

Yes, that's exactly right. I mean, we've built in an expectation that short rates will rise faster than long rates over that time frame. So we've already got that built in. Even if that occurs, we can still stay on this path. And it's anchored not only to our 5% asset sensitivity but the fact that, that will actually moderate over time along with the flattening. So that's built in.

And we can go to the next question that will come from Scott Siefers of Sandler O'Neill + Partners.

Let's see, John, maybe best for you, but a question just on the loan growth guidance. So it looks like, as you look into the first quarter, pretty steady rate of growth with what you've been doing recently. But to get to the full year guidance, it looks like it might take a little bit of an acceleration throughout the course of the year. One, am I interpreting that correctly? And two, just maybe a little more color on what the drivers would be behind any acceleration.

Yes. I mean, that's right. You've got that right. We're coming in around 1% for the first quarter. And to get to that 4.5% to 5.5% that we're talking about, things will pick up later in the year. I mean, we came out of 4Q, and we saw that in the industry as well as in our own businesses, a little bit of softening in some of our areas that we're -- we strive for that loan growth. But we're seeing some pickup, and so pipelines are strong. And as we go through the first quarter, if we can realize those pipelines and see the pull-through that we expect, and we'll see a pickup later in the year. The key areas that will drive that on the consumer side continue to be education loans and mortgage as well as unsecured. And on the commercial side, we've been investing in our geographies, in our growth markets and up-tiering talent along with that geographic expansion. And so those things will continue to drive growth into 2018.

Yes. I would add to that, John, and say that I think the consumer side has been relatively consistent. So we kind of get the run rate of 5% annualized growth almost quarter in and quarter out, where we need to start to see the build is on the commercial side. And I think as John indicated, the pipelines are good. I think there's been some pent-up demand looking into Washington and some uncertainty what was going to happen now that that's been resolved, and I think there's positive sentiment towards the tax cut. Hopefully, that releases some animal spirits and we get more loan demand and a follow-through as the year goes on. So we would expect to see the commercial side pick up a bit. Don, do you want to add any color to that?

I think that's right. I think -- just to echo what John and Bruce said, I think we are seeing the pipelines build. We're seeing the M&A pipelines build faster than the loan pipelines. We think the loans will follow the M&A pipelines and are indicative of new money demand that we might see. And I would remind people that we really rolled out the regional strategies midyear last year, so they're going to begin to take hold this year as we add new clients. So it will be a combination of more activity with our existing clients and then adding new opportunities into the book.

Yes, great.

Okay, that's perfect. And then, if I could just ask one more on the margin. So obviously, some pretty decent expansion here as you look into the first quarter. I guess I'm just curious how you see the progression going throughout the year? I guess, my initial guess would have been the guide could have been even a little bit higher. Just trying to figure out if that's conservatism or any sort of change in anticipated deposit betas or how you see things progressing.

Yes, I'll go ahead and get started -- I'll start off on that. But the outlook is 9 to 12 basis points for 2018. In terms of deposit betas, those are built in, where deposit betas are behaving as expected at this point in the tightening cycle for us. We did have some expectations that betas would continue to increase the farther we get into the tightening cycle. So that is built in to the 9 to 12 basis points that we're talking about. And so I think by -- as we do get that April and October move from the Fed, we'll be right on target with moving towards the potential of a 300 basis point through-the-cycle move, and we're right on track from that perspective. So we feel pretty good about that NIM outlook given what we've built in on betas.

And our next question comes from Geoffrey Elliott with Autonomous Research.

On capital, it looks like you've got some rundown built in, but really not targeting CET1s much lower than you did previously, despite the fact that we seem to be entering a looser regulatory environment. Why is that?

Let me go ahead and start off. I mean, we've been targeting this approximately 40 basis points or so of capital decline glide path over time. I think that serves us well over a couple of -- through a couple of lenses. We still have opportunities for deploying that capital. And when we find opportunities to deploy that capital organically in an accretive way, we think that's a good use of the capital. We continue to compare the ability to deploy the capital against what the economics would be of a buyback. And when we find opportunities that are accretive, we would deploy that on behalf of shareholders. And that glide path over time, we will resume that march downwards. This past year, we were the victim of basically higher earnings and a little bit lower RWA usage, as we talked about earlier on the call, in terms of loan growth and, of course, the tax legislation. So I think there are some unique factors that were at play in 2017. And I think we'll get back on that glide path of reduction on CET1 in 2018 and beyond.

And I think in the -- yes, I think, Geoffrey, the -- getting down to 10% to 10.25% is part of the medium-term target, and there's a bunch of things that go into that. It's the posture that the regulators have regarding the stress test, but then also the rating agencies and what you're targeting in terms of your credit rating. And so I think the good news here is that we can get to very acceptable ROEs -- medium-term ROEs, and still maintain what we think is a strong capital position that gives us flexibility, as John described.

And I think in the past, when you've been asked about bank M&A as a channel for deploying capital, the answer has been not yet. But 3 years out post the IPO, you've hit the initial targets, is that changing at all? Is there any more appetite for bank M&A?

I'd say there's really no change there. There is beginning to be an appetite to do what I would describe as fee-based bolt-ons. So the Western Reserve M&A boutique that we bought in 2017, I think, was a great transaction. And it's working really well, integrated well, and we're getting lots of 2-way flow with that property. I think we could do more things in commercial, in the capital markets space to keep building out our capabilities over on consumer. We have, I think, a desire to really capture the potential that we have in wealth management in the organization. We've been doing that organically, and so there could be opportunities potentially to add through acquisition there. And then, I'd say there's other opportunities around mortgage, for example, buying MSRs if you want to count that as an acquisition. That's another thing and maybe some things in the payment space and some of the things we're doing with fintech. So I think we've built the capabilities now. We have a strong team that can look outside the organization to spot opportunities and react to opportunities. But again, I think it's walk before you run. It's do relatively safe, well-thought-out deals that are right in the middle of the fairway that are accretive and get us like, I like to say, farther down the track faster versus an organic pathway. And then, the rest of it is let's keep focused on running the bank better and getting that organic growth, and let's not get distracted going off and looking for bank M&A.

And we'll go to the line of Kevin Barker with Piper Jaffray.

I noticed that some of your deposit growth has been decent, and then your deposit base have also started to slow a bit from the beginning of the year. Could you just give us a little bit of color on what you're seeing as far as deposit competition, specifically in the Northeast, and how you see some of the go-forward deposit betas, at least in the next couple quarters?

Okay. I think this will be a team effort. But Brad, why don't you start with the color on the consumer side and some of the geographic markets that we...

I would say, for the most part, competition has been pretty well behaved. We've seen a little bit of increased competition on the money market side, but for the most part, the competition has been pretty well behaved -- or the deposit costs have been well behaved and competition has been pretty attractive. We are continuing to make investments in our ability to be more targeted in our deposit offerings. So we're really moving away from promotional pricing and investment in analytics and the ability to do targeted digital offerings, targeted direct mail offerings, which we think will help us keep our deposit costs low and keep our betas in check. But competitively, we feel pretty good about where the market's been.

Don, do you want to talk about the commercial?

Yes, I'd say the same thing. I mean, it was really beginning -- at the beginning of last year, I felt we really organized the business around strategic deposit gathering. And before that, I think we were lurching a little bit in and out of the market in terms of gathering deposits, and we're now managing over a multi-quarter basis. So that's helped us gather with our core clients in a much better way and contain costs at the same time.

Yes. John, do you want to fill in the blanks on the betas?

Sure. Yes, on the betas, you're right. I mean, I think we mentioned last quarter that we expect the betas to be lower this quarter. There wasn't a Fed move that would drive it in 4Q. And so that occurred, and as expected, I think looking forward, you could think about similar behavior in the quarters in which there's a Fed hike and the quarter that -- after the Fed hike, you can see betas rise, and that's as expected. We're right on our glide path in terms of where we expected to be on betas. We're in the low 20s on beta, just up a tiny bit from 4Q -- in 4Q. And we expect that to stay in the 20s as we see things progress throughout 2018, maybe getting up towards 30%. If we get those 2 hikes, we'll be more than halfway through an overall tightened cycle, and we'll be about halfway through our overall beta estimate of around 60%. So things progressing on plan.

And then, a quick follow-up with the other side of the balance sheet. The other retail consumer loan growth has been fairly robust, especially this quarter, up 23%. And it's one of the higher-yielding asset classes. Could you just describe some of the puts and takes and why that's growing at the level it is?

It's been a good quarter for us on the unsecured side. So our partnerships, including the Apple relationship, has been strong. So we've seen good growth there. We've seen good growth in our PERL product, our personal unsecured loan, and we see upside in both of those areas. And we've seen continued strength in demand for the ERL product as well. So all of those are good risk-adjusted assets, and we see some good runway in all of those products.

Yes. And I think what's interesting to note is that we have a pipeline of potentially some other partners that are going to be coming onstream as the year goes by, which should continue to add to the growth.

Exactly.

Yes.

And your next question comes from Matt O'Connor with Deutsche Bank.

Can you talk about some of the fee revenue drivers in 2018? I think you had some pretty big upgrades in the treasure management and mortgage, and obviously, the mortgage market's a bit in flux here with [flow of] refis. But maybe talk about fees in general and then those 2 specific areas, how meaningful the opportunity could be in those.

Sure. Why don't I start, and then, John, you can provide more of the details. But I'd say that we still remain quite positive on the trajectory we've had on the commercial side of the house. So we've been adding clients and building up our capabilities so that we can do more for those clients. So that's a very strong, powerful combination to have broader capabilities and a growing client book. And so if you look probably over the last 3 years, I think our fees on the commercial side have grown in double digits, low double digits, 11%, 12%, really, on the back of capital markets. And then also, we have what we call global markets, which is FX and interest rate hedging, which we used to do in conjunction with RBS, and we're able to break that away and set up a great operation on our own. So those, we expect to continue to grow. And as you mentioned, Matt, what we call treasury solutions here, the cash management business being the biggest element of that, should get a real kick, probably not till late in the year because the re-platforming starts to roll out late this year. But I think we've made steady improvements to the platform, and now we're going to take a step function to having a really terrific platform. And so, I think we'll start to get even more traction on treasury solutions. Treasury solutions, I think, has been growing in the high single digits even without that. So we've had strength in our card offerings and our payables offerings and some of the other areas but not as much in the core cash management space. And then, on the consumer side, really, the wealth to us remains the really big upside area. And we've fought a few headwinds by having a mix shift in kind of how we approach the business and how the business plays out in terms of products. But we're moving much more towards a managed money orientation as opposed to a transactional orientation around annuities. And so in the short term, that's been a headwind. But in the long term, that's actually quite positive because it will build up a more annuity-like book of revenues. And I think those lines are getting pretty close to crossing. And you can see, in Q4, we had a nice step up, and we would expect to see that continue. Mortgage, as we've talked about, we've had fits and starts in that business. I think we now have a strategy that focuses more on conforming in the mix. So let's really get the retail channel the way we want it, more focused on conforming. Let's move and invest in our direct-to-consumer business, and then, let's get scale in the servicing by buying some MSRs. So I think we have a good strategy there. We've actually built a very good platform. Our fulfillment and servicing capabilities are very strong, so we think that business will contribute as well. So that would be my kind of long-winded highlight, and I don't know if I left any breadcrumbs for you, John, to fill in. But go ahead.

No, you got most of it, Bruce, and you covered a lot. I think the theme is we've invested in all of these fee income capabilities by adding fees in wealth, adding loan officers in mortgage, the leadership investment that we made across the commercial space, re-platforming. We've done product enhancements in advance for the re-platforming. So all of that will drive towards a mid-single-digit growth that we're targeting for 2018 on the fee side, and we're going to be working hard to achieve that goal.

I might just add one thing on the mortgage side. You talked about the shift to direct-to-consumer. Really, our growth up until now has been almost exclusively through hiring loan officers. But as we've been doing that, we've been making a big investment in building the capability for direct-to-consumer, so building the data and analytics that really need to underpin your ability to do direct mail and digital offering. And that investment has been made, so we think we really are at a point where we can launch (inaudible).

Now you just got us stir in some marketing dollars and there you go. Good.

Yes, exactly.

And we'll go to the line of Ken Usdin with Jefferies.

I was wondering if you could talk a little bit more about the BSO part of the TOP/BSO. And maybe help frame us in terms of whether it's in terms of the 9 to 12 basis point NIM expansion for '18 or just a broader sense of -- how much upside do you see from that program specifically and separate that from rates maybe?

Yes. So if you look historically, Ken, we've probably approached close to 50-50 on the contribution from our NIM expansion from BSO. It wasn't necessarily a formal program but just the steps that we're taking to focus on the mix and sharpen our pricing and being selective about where we play. I think when we were up 18, maybe 8 of that or so was coming from BSO and the rest was coming from rates. So we tried to really look through and capture that. And then, I think going forward -- so in recent quarters, it's been a little less. It's maybe 35%, maybe 40%, but still a meaningful contributor. So I think one of the goals we have is to close the NIM gap that we have with the peer median. And we know where the gold is. We've got to go mine the gold. So we know we still have mix work to do. We still have some pricing work to do, and we have now, I think, at this point, under John's leadership, put this into a more formalized program, where we'll have tasks and we'll monitor progress, just like we do with the TOP program. So that's really some background there. John, you can add some additional color.

Yes, just a point or 2. I think a good way to think about it when you're in an environment such as 2018, where we expect rates to move and we've got 9 to 12 basis points, I think the number that you heard from Bruce, around 30 to 40 basis -- 30% to 40% is a good way to think about what BSO will contribute. And in a period where there is no rate move, really, a lot of the drive comes from BSO. So for example, in 4Q, there was a little bit of rate overhang left in 4Q, so about 3 basis points that you saw in 4Q, maybe close to 2 of that came from BSO because we didn't have a rate move. But again, when you get out to '18, we'll go back to 30% to 40%, as you heard from Bruce. So that's -- hopefully, that helps you think about it. And actually, really, it doubles down on, in an environment where there is no rate move, we're still focused on self-help, and we're still driving net interest margin in an environment like that.

Okay, great. And then, just a follow-up specifically more on some of the loan buckets that continue to run down as part of it. Do you eventually get a line of sight into the home equity and auto? And where and how far out do you see just stabilization in those parts of the buckets? Or are they just kind of continually drift down?

Yes, I'll start off and maybe turn it over to Brad or Bruce or whomever wants to add in. But I think the -- I think auto will be a gradual glide over the medium term. And we frankly use that as a way to drive upside in yields by finding higher risk-return opportunities in the education space or in other areas in unsecured, and that allows us to run down the auto book on that kind of path. So that will give you a sense for basically what we expect there. And maybe I'll let Brad to add a lot of details.

Yes, so let me add on the home equity side. So there's an interesting dynamic on the home equity side, which is that a home equity line of credit has a 10-year draw cycle, and then it moves into repayment. So for the industry and for citizens, the big books of origination were back in the 2004, '05, '06, '07, '08 time frame, so our largest books that are hitting into the draw period come to an end in 2008. So that's really what more of the drag has been for both the industry and Citizens. We've seen the home equity portfolio grow. We had a big step down in home equity lines starting in 2009 that hit the end of the draw period. So we do think that -- I'm sorry, 2019 is when we will start to see home equity grow because we won't have that headwind of those large books hitting into the draw period.

Yes, so we would -- when we look at the HELOC on a risk-adjusted return basis, it's very attractive. And it's a great product for the mass affluent, which is a key segment of our consumer base. So we're still investing in that business. We've really improved the customer experience. We have great net promoter scores. We're going through a much faster fulfillment cycle. So I think we're very keen on that business. On auto, I'd say we've been using that when there was not much loan demand. We ran it from $10 billion or $11 billion up to $14 billion, and now we have it back down in the $13 billion, and it's running back down to $10 billion or $11 billion. So that is, because it's a 2-year duration, relatively short portfolio. We can use that as a shock absorber based on what other loan demand is out there in the marketplace. And right now, we're in a mode of withdrawing capital from that business. But the HELOC has been, as Brad said, more environmental. We want to grow that business. We're actually putting new lines on the books, but we're still suffering from paydowns.

And those paydowns, that -- the end of those draws drop at about 1/3 between '18 and '19, so that's a big dynamic.

So I was just going to add one thing. Our direct-to-consumer marketing effort in home equity has been really successful following the buildout of that data and analytics. And we improved our originations on that channel from about $150 million in 2015 to over $1 billion in 2017. So that's an example of...

So it's not -- that investment is not just paying dividends in the mortgage business, it's also in the HELOC business, and it will be in all our portfolios.

And our next question in queue will come from Vivek Juneja with JPMorgan.

A couple of questions. Consumer efficiency ratio, Bruce, John, still pretty high at, give or take, 72% last few quarters. What's your outlook on that? What will it take to get that down meaningfully? Because obviously, we've had rate hikes. The rate hikes have obviously greater benefit upfront. So is that a question of scale? Or what do you think you need to do to get that down meaningfully?

Yes, I'd say it's a combination of things, but the same positive operating leverage that works for the company is what we have to affect in the consumer business in order to keep driving that down. I think it -- actually, when I was here, it probably was close to 80%, so we take good headway in getting it this far. There's a number of things that are going on, on the cost side of the equation. Brad's been a leader in the TOP programs and looking for efficiencies in straight-through processing, and that will continue. We're trying to reduce the overall size of the branches in terms of our branch transformation efforts. So there's a little bit of pruning of the number of locations, but the greater element of that program is trying to take 4,200 square foot branches and turn them into 2,500 or 2,200 square foot branches. And so we're -- I'd say by 2021, I think we'll have gone through 50% of the branches is the target. So we're focused on that. That will continue to [hive] down some of the costs. And a good chunk of that will be reinvested in digital. But I think you can get more efficient in terms of your touch points with your customers in a digital sense than versus the higher-cost, full-branch structure. So anyway -- so there's good work going on, on the expense side of the house. And then on revenues, we've got to get back to growing households. We think some of the investments that we're making in having well-thought-out products at 4 different segments for the affluent -- the mass affluent, the mass customer is gaining traction, so that's helpful. We've invested in something we called customer journeys to try to really make like, for example, the account open experience -- opening experience be really pleasurable for the new customer, and that has a good impact on keeping that customer. The fraud experience problem resolution, there's a number of these journeys that we're reengineering from front to back, which I think will help boost the top line by reducing attrition, increasing loyalty and increasing cross-sell. And the consumer portfolios also are contributing. So as we grow personal unsecured and education, et cetera, those portfolios drop a lot of net interest income to the bottom line. So I think what we're expecting for the whole company in terms of driving that efficiency ratio down, we have to get that from consumer. And we see it. We have a path to do that.

Completely different question, I'm going to shift gears. Any commentary from your folks and from Don and Brad on loan pricing terms you're seeing in the various categories?

Yes. In -- on the commercial side, it's as aggressive as it's ever been. And it's basically deal by deal, borrower by borrower. I think it's been down-drafting materially for several quarters, if not several years. So I think we're getting to a point where you're probably not going to see material incremental downdrafts. So I think we've seen a lot of it, although every transaction is quite competitive both on-bank balance sheets and off-bank balance sheets through just an [immediation] of the bond markets and the nonbank markets also. So it's an environment that we've been operating in for the last several years, and we expect it to continue, but we're navigating it.

And I think, Don, you can comment on this. But probably, the new new thing is the non-bank competition has really picked up.

And that's significant in the leveraged finance businesses and the underwriting businesses. I think for us, some of that's being offset, and the one thing we didn't talk about in terms of the progression of the fee revenues is in addition to the investments we've been making, they let us take increasing leadership positions in the transactions that we're involved in. So while we were a participant several years ago, we were moving to joint lead arranger and now we're moving to an arranger, which while we're growing those business also is allowing us to capture a greater share of both balance sheet economics and fee economics on a transaction-by-transaction basis. So as you know, it's kind of a put and take constantly, but net-net, we're doing pretty well.

I would say on the consumer side, we haven't seen a lot of change. It's been pretty -- certainly, the market has been rational, without question. There's been a few competitors who have entered in the ERL space, the education refinance space, but it really hasn't moved the market much. And in fact, I would say on the auto side, we've maybe seen margins even widen just a little bit on the auto side, which has been encouraging.

And our next question in queue will come from the line of Peter Winter with Wedbush Securities.

The provision expense, when I look at credit quality, it's been very good, and then the guidance for the provision expense for '18, the range is a little bit higher than what I was looking for. And I'm just wondering, the reserve build, is that a function of keeping reserve-to-loan ratio fairly steady with the loan growth? Or would you want to start building the reserve with more growth on the consumer side?

What I'd say, Peter, first off, is that's about the guidance that we gave for 2017 was, I think, the same exact range that we're giving for 2018. So we were very favorably surprised by how strong the environment was and how all of our credit metrics improved. I think, when you now turn the calendar and look at '18, one of the questions is, we want to get the loan growth in the range that we talked about. Midpoint of that is 5.25% or something like that, so you would be adding to reserves to fund the loan growth. What happened this year is that, even though we thought that the cupboard was pretty bare in terms of problem credits or back book issues, we still had a lot of positive surprises. So whatever we needed to fund in terms of the allowance build, we actually had offsets coming in, in terms of back book improvements. I don't know if you can -- again, if you're really, really clean, can you count on that happening again? So I think we're being conservative here in just saying, well, let's assume we get the loan growth and let's assume we don't have a lot coming from back book credit improvements, then that would start to move your provision number higher. There's also a little bit of seasoning in some of the consumer portfolios that will start to move the charge-off number up a little bit, certainly, well behaved and in control. But that would also be a factor that comes with the good thing if all the net interest income that's been delivered. So anyway, I'd say that's our call at this point. If 2017 -- 2018 plays out like 2017, there could be some positive upside there.

Great. And just a quick follow-up. If Congress were to raise the SIFI threshold, would that accelerate the medium-term target on your common equity Tier 1 ratio?

No. This is John. No, I don't think so. I mean, I think that we set that target in part related to business opportunities that we talked about before and the fact that we continue to have organic and other opportunities to deploy capital over time that are accretive, that we want to balance against the capital return and just where we are in our life cycle as a company post IPO. It just feels like an appropriate glide path. Whether that SIFI threshold was at $50 billion or $250 billion, we, of course, are supportive of that directionally and believe that, that would help moderate the interactions that we're having with the regulators. But I think the glide path would remain.

And the next question in queue will come from Gerard Cassidy with RBC Capital Markets.

This is actually John Hearn on for Gerard. Just a quick question on the commercial utilization rates in the quarter. Could you tell us where they were and then, just how that compares to where they've performed in the past?

Yes. I mean, I think they're right around mid-30s and staying relatively stable across the year, up and down a tick, and up a little bit year-over-year. So maybe low-30s ending 2016, getting into low to the mid-30s here at the end of 2017. So about as expected.

Okay, got you. And then, just one follow-up from your earlier comments on the merchant financing programs. Do you expect [them] to announce some partnerships this year? And I know there's a degree of risk-sharing there with the partners, so is that expected to continue as new people join in?

Yes, so I'll start. Brad, you can complement. But yes, I think we will have more announcements this year. We're working on some things that are in pilot, and so stay tuned. But this is -- I think we provide a very high-quality customer experience and a good partnership experience for our partners. And so there's other folks who want to see if they can do a program similar to what we've pioneered with Apple. And I think each of the arrangements has its own negotiation around how the economics are going to work. And so, kind of the pricing that we get is oriented around a targeted rate of return. And so, if there's more loss-sharing, then we don't need as much for the use of our balance sheet and vice versa. So anyway, we're pleased, in general, that we can offer the flexibility. We can construct these things around the rate of return, and we think that the risk-adjusted rate of return that we're getting are attractive at this point, so...

Yes. I really don't have anything to add other than I agree completely. We expect to have more partnership announcements this year and expect to have them -- some degree of risk-sharing to all the partnerships.

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

On Slide 17, it looks like most of the funding growth has been coming from the term deposits or time deposits. Can you just talk about that? Like I'm just curious more of the strategy. It doesn't obviously seem to be having an impact on your margin or your deposit base today, but I'm kind of wondering how that plays out over the next year or so.

Yes. I mean, I think that we use all of the tools in the toolbox there with respect to our deposit categories. And from time to time, we'll have a promotional strategy on term, which allows us to control cannibalization and other things that may happen in a promotional approach. But we're more pleased with our DDA growth. And really, that's the driver of all of the initiatives that you're hearing about coming out of the consumer space, with all the investments that we're making there in terms of better pricing and investments in data and analytics and the targeting that we're doing there from a digital perspective. So our emphasis is on DDA, and from time to time, we can serve our customers in a promotional way through term.

I mean, I think you said it well. We think there's good opportunity in continued DDA growth. We're pleased with the progress we had there this year and feel optimistic by that.

Got it, okay. And then, just last question. In terms of the capital markets business, obviously it ticked down a little bit this quarter, but from a higher pace over the last couple of quarters. I mean, was there something unusually negative in this quarter? I mean, should it bounce back towards that $50 million range? Or is it just -- I'm trying to think of what the outlook is. I mean, I understand the total fee guidance is what it is, but...

Yes, I think the way I'd answer that is it's going to be a moving mix of fees based across M&A and bond underwritings, syndicated lending and leveraged finance based on deal flow that's materializing. I will say with the changes in tax legislation, we expect more activity in general. There was one slight anomaly in the fourth quarter, is that we pulled a couple deals forward into the third quarter in terms of closings, and a few pushed into the first quarter. So there was always the timing difference. And we did see people both on the M&A side and on the syndicated loan side basically migrate around the year-end based on what the individual tax aspects of their transaction are. So I look at it not on a quarter-on-quarter basis but on a year-on-year basis, and you're going to have quarterly anomalies. I think we feel good about the, as I said before, the breadth of that business now, the position we have in terms of underwriting, we're climbing up the [league] tables, and the swings we're having based on the size of the client base and the fact that that's growing.

And Ken, you may recall the trajectory that we used to put up quarters in the 20s for capital markets, then we hit the 30s, the 40s, 50s. And I was joking that 50 is the new 30. But I think there'll be some volatility based on market conditions and when deals close. And so we're pleased that the investments we have in the business have borne fruit, that the environment has been healthy. And we would expect the capital markets, on a year-over-year basis, to be up in 2018 versus 2017.

And our last call -- question in queue will come from the line of Marty Mosby with Vining Sparks.

I wanted to focus on the balance sheet kind of optimization. And in all your kind of guidances [when] you get to funding, you talked about loan-to-deposit ratios, and you're bumping up against that 100% level. But given the methodology of liquidity coverage ratios, shouldn't that be the driving force for liquidity versus your loan-to-deposit ratio? And do you see 100% as any type of constraint on your balance sheet and loan growth?

Okay. Well, we have actually worked to try to bring that down gradually. So the history was, we were probably in the 93% zone when I arrived, and we needed to sell the Chicago region to fund the separation from RBS and some charges we had to take. So we took the gain, and that ultimately removed, net, about $5 billion of deposits that put the LDR up around 99%. We printed a year-end spot of 97.6%, and our guidance has been to bring that to 97% to 98%. I do think there's still a psychological impact if you go over 100%, so I do think we'd -- are working to keep below that and maybe, over time, bring the LDR back towards 95% or so. Having said that, I think another thing is happening. As you point out, the LCR is actually a much more sharp instrument to determine what's the nature of your actual liquidity and funding position. And so there, we've had a very strong LCR just because we have, in the deposits, the high percentage of our deposits come from consumer, which stress test very, very well. And we've termed out all of our borrowings. We have the same kind of term funding structure that our peers do, which we didn't have originally. So when the LCR begins to be published, and I think investors pay more attention to that, I think the LDR, over time, becomes a secondary measure. But at the current time, we're still managing it. We're pleased with where we have the LCR, and we feel very good about our overall liquidity and funding position.

The other thing is, when you talked about your long-term kind of goals and profitability, one of the things that you said under your operating assumptions was asset sensitivity moderates as rates normalize. Does that encompass neutralizing the asset sensitivity because (inaudible) you have is about $7 billion, and needs to be extended or neutralized.

No. It just happens naturally. So as rates are higher, deposit betas go up, and so you capture less from the moves that are late in a hike cycle as opposed to the early ones. And so we're not intending to say, "aha, this is the precise moment to put a big hedge on and neutralize our sensitivity." In fact, we've actually tried to maintain it a little bit here, and we'll just let it glide down naturally with time.

And that does -- I'll hand the call back over to you, Mr. Van Saun.

Okay, great. Thanks, everyone, for dialing in today. We appreciate your interest and also your support along our journey. We're pleased with the progress that we're making. We recognize, however, that there's still plenty of work in front of us to build a truly great bank. So thanks again, and have a great day.

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