Citizens Financial Group Inc (CFG) 2018 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Citizens Financial Group Third Quarter 2018 Earnings Conference Call.

My name is Brad, and I'll be your operator on the call today.

(Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the call over to Ellen Taylor, Head of Investor Relations.

Ellen, you may begin.

Thanks so much, Brad, and hello, everyone.

We really appreciate you joining us today.

We're going to start things off with prepared remarks from our Chairman and CEO, Bruce Van Saun, and CFO, John Woods, who will review our third quarter results.

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

We're also really happy to have in the room with us today, Brad Conner, who is Head of Consumer Banking; and Don McCree, Head of Commercial Banking.

In addition to a release, we have a presentation and financial supplement available at investor.citizensbank.com.

And of course, I need to remind you that our comments today will include forward-looking statements, which are absolutely subject to risks and uncertainties.

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

We also need to remind you that we utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our SEC filings and our materials.

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

Okay, thanks.

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

We're pleased to report another very strong quarter today paced by strong top line growth of 7%, excluding FAMC, Franklin, and good expense discipline, which combined for a positive operating leverage of 4.4% year-on-year.

We continue to achieve good balance sheet growth in the current environment with sequential loan growth, excluding FAMC of 1% and year-over-year growth of 4%.

And that's a very good result considering we're still running off noncore assets and reducing our auto and leasing portfolios.

We've focused on some great niches on the consumer side, and we've invested in broader coverage on the commercial side to achieve this growth.

Our strong execution to date in 2018 has led to some very nice improvement in key metrics.

EPS growth year-on-year is 37% underlying and 34% on a year-to-date basis.

Our ROTCE reached 13.5% underlying, which is into our target range of 13% to 15%, and the efficiency ratio was 58% underlying.

We're confident in our Q4 outlook, and we expect to finish the year strong.

Our capital strength continues to be a real advantage, as we have the capacity to grow our balance sheet and drive organic growth.

We make small smart fee-based acquisitions and to return significant capital to our shareholders, which we did and exceeded $500 million in the current quarter.

We have a couple of great slides in the deck today, covering our progress against our strategic initiatives and some of the recognition we've been garnering.

I've just crossed my 5-year mark at Citizens, and I feel really good about how we've been able to turn around the bank and shift from defense to offense.

We now have a clear view of what it will take to be successful longer term and become a top-performing bank, and we are making significant investments to position us well for the future.

That said, we understand the need to deliver consistently strong and improving results each quarter, and I feel our team has done a great job of getting that balance right.

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.

And good morning, everyone.

We delivered another strong quarter that highlights steady execution against our enterprise-level initiatives, with particular focus on robust positive operating leverage.

We continued our momentum in delivering cost efficiencies while making the long-term investments required for sustainable success.

Some quick highlights.

We grew our underlying EPS 37% year-on-year.

We delivered operating leverage of 4.4%, excluding the impact of the Franklin American Mortgage acquisition, which closed on August 1. We continue to make progress on improving returns, with underlying ROTCE for the quarter of 13.5%, up nearly 60 basis points linked quarter and 340 basis points year-over-year.

Our Consumer and Commercial Banking segments are delivering improved returns by driving prudent balance sheet growth and controlling our deposit costs in a very competitive environment.

Across both business segments, we are growing our customer base, deepening relationships, broadening our capabilities and investing in new technologies to enhance the customer experience.

I'll expand on our strategic initiatives a little later.

On Slide 3, we provide information on the Franklin American acquisition and related integration costs.

And in order to make it easier to see underlying trends, we show you our results without the integration costs and provide further color on our results, excluding Franklin, on Slides 4 and 5. As I mentioned, you can see that we delivered positive operating leverage of 4.4%, excluding the impact of Franklin, with an efficiency ratio of 57%.

Also, PPNR growth year-over-year was 13% excluding Franklin.

On Page 6, net interest margin results came in as expected, with a 2 basis point increase excluding the impact of Franklin, even though average LIBOR rose less than anticipated.

We are pleased that despite a fairly competitive landscape, we continue to drive disciplined balance sheet growth and delivered a 2% sequential quarter increase in net interest income.

Turning to fees on Slide 7., you can see a $28 million improvement driven by mortgage banking fees given the addition of Franklin.

Excluding that impact, fees were up 1% linked quarter and up about 3% year-over-year.

Our capital market fees were relatively flat sequentially this quarter, notwithstanding some pretty significant headwinds in this space.

But overall, loan syndications market volume was down approximately 40%, but we were down less than the market in this space.

An offset to syndications volume was bond underwriting, where we continue to gain traction, and M&A advisory fees, given our ability to leverage the Western Reserve Partners' acquisition.

In global markets, where we continue to build out our offerings, fees were down slightly from record second quarter levels, reflecting a $3 million adjustment related to a CBA methodology change.

Interest rate product fees were down 4% due to a decline in variable rate loan demand and the impact of the flattening yield curve.

In FX, we held our ground by being proactive with clients against the backdrop of increased dollar volatility and looming trade policy concerns.

On the consumer side of the house, we saw good traction in our Wealth business, with increased sales volumes and a 5% linked quarter increase in managed money revenues and 23% growth year-over-year.

And in our mortgage business, we've hit the ground running with the integration of Franklin.

We are very excited about the scale the business brings us in servicing and the opportunity to serve over 200,000 new customers.

The integration is on track, and while the current environment is challenging, we continue to believe this is an attractive and important customer business for us to be in over the long term.

Turning to Slide 8. On a reported basis, our expenses were driven up by the impact of Franklin and about $9 million of integration costs, largely in salaries and benefits outside services and other expense.

Excluding Franklin, we are pleased to report that linked quarter expenses were flat given continued strong expense discipline and benefits from our TOP program.

Let me elaborate a bit on that.

Our commitment to sell funding investments continues to drive our ability to ensure our expenses remain well controlled.

This is a direct result of all of the work we've done over the past few years with our TOP programs.

The efficiency and revenue benefits from those programs have a compounding effect that has funded our growth initiatives, allowing us to expand our capabilities across the bank and facilitate various business initiatives, such as Citizens Access and many others.

Let's move on to discuss the balance sheet.

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

Despite slower growth across the industry, we continue to see strength in certain segments in Commercial.

This was against a backdrop of heightened nonbank competition and very liquid corporate balance sheets given the benefits of tax reform and repatriation.

And while we are very selective about CRE, we are still finding some attractive opportunities for growth.

On the retail side, we saw nice traction in some of our attractive risk-adjusted return categories like education and unsecured as well as important categories like mortgage.

Overall, we grew loans by 1% linked quarter.

As a reminder, we sold corporate loans late in the second quarter, which had about a 25 basis point impact on third quarter growth.

Loans grew by 4% year-over-year notwithstanding headwinds from the planned runoff in auto, noncore and leasing, which was around $1.6 billion year-over-year, which impacted the growth rate by about 1.5%.

So gross of our planned runoff, our loans were up 5.5% year-over-year.

Loan yields improved by 12 basis points in the third quarter, which was lower than what we saw in the second quarter.

This reflects the backdrop of a lower increase in average LIBOR over the same period, which had a corresponding benefit to our overall funding costs.

Also, we continue to see results from our balance sheet optimization efforts and remain well positioned to benefit in a rising rate environment.

I am pleased with what we were able to accomplish in deposits this quarter.

As you can see on Slide 10, we continue to do a nice job of growing deposits, which were up 2% linked quarter and 4% year-over-year.

And in particular, we continue to gain traction on DDA balances, which were up over 1% linked quarter and 4% year-on-year, excluding the escrow balances contributed by Franklin.

Our total deposit costs were well controlled, up 10 basis points compared with an 11 basis point increase in the prior quarter.

The interest-bearing deposit costs rose at a slower pace this quarter as well, increasing 14 basis points compared with a 15 basis point increase in the second quarter.

For the most part, deposit costs have been relatively well behaved despite increased deposit competition we are seeing in the industry overall.

Our cumulative beta on interest-bearing deposits is in the low 30s as expected, and remains in line with our overall expectations given where we are in the rate cycle, and given the actions we are taking, we expect cumulative betas to remain relatively stable in the fourth quarter.

We continue to be optimistic on the trends of deposit costs.

We are benefiting from investments that began back in 2016 in areas like increasing our brand marketing spend to closer to peer levels and in analytics to improve our targeting through digital and direct mail offerings on the consumer side.

In Commercial, we are making investments to build out additional product capabilities like escrow services and are rolling out our new cash management platform early next year.

Also, in July, we launched Citizens Access, which contributes to our funding diversification and optimization of deposit levels and costs.

Through the end of the quarter, we raised about $1 billion, and we expect to hit about $2 billion of deposits by the end of the year.

While this is a relatively modest part of our overall deposit strategy, we are very pleased with the progress so far.

About 97% of these deposits are from new customers and the average account size is about $70,000.

We are right on target with the type of affluent customer we are looking for.

Year-over-year, our asset yields expanded 47 basis points, reflecting the benefit of higher rates and the impact of our BSO initiatives.

Our total cost of funds was up 35 basis points, reflecting the impact of higher rates and a continued shift to greater long-term funding.

This included the impact of the $750 million senior debt issuance late in the first quarter of 2018.

Our borrowing costs were positively impacted by the slowing pace of LIBOR this quarter.

We also benefited from the mix shift this quarter as we redeemed higher cost sub debt at the end of June and replaced it with lower-cost FHLB advances.

Next, let's move to Slide 11 and cover credit.

Overall credit quality continues to be strong, reflecting the continued mix shift towards higher-quality, lower-risk retail loans, and a relatively stable risk profile in our commercial book.

The nonperforming loan ratio improved to 73 basis points of loans this quarter down from 85 basis points a year ago.

The net charge-off rate of 30 basis points for the third quarter was relatively stable linked quarter and upped modestly year-over-year from relatively low levels.

Retail net charge-offs were up modestly reflecting seasoning in the portfolio, which is very much in line with our expectations and performing in line with the modeled loss curves.

Commercial net charge-offs for the third quarter were relatively stable versus last quarter and up from the prior year, which benefited from higher recoveries.

Overall, we feel good about the credit metrics and trends in the book, including a meaningful drop in criticized asset levels, reflective of continued favorable credit quality.

Provision for credit losses of $78 million declined from the second quarter with particular improvement in the retail real estate secured portfolios.

Our allowance to loans coverage ratio remained relatively stable ending the quarter at 1.08%.

And as we increased the mix of higher quality retail portfolios in our overall loan book, the NPL coverage ratio improved to 149% as we saw continued improvement in NPLs and runoff in the noncore portfolio.

On Slide 12, we continue to maintain strong capital and liquidity positions, ending the quarter with a CET1 ratio of 10.8%, which came down from 11.2% in the second quarter, with approximately 18 basis points of impact from the Franklin acquisition.

Also this quarter, we repurchased $400 million of common stock and returned a total of $529 million to shareholders including dividends.

Our Board of Directors has declared a dividend of $0.27 a share, and we have the ability through CCAR to increase the quarterly dividend another 19% to $0.32 per share, beginning in the first quarter of 2019 subject to our board's approval.

Our planned glide path to reduce our CET1 ratio remains on track and we remain confident in our ability to continue to drive improving financial performance and attractive returns to shareholders.

Third quarter achievements against our enterprise initiatives are highlighted on Slide 13.

I'll point out that we are making traction on our balance sheet optimization effort as we recycle capital out of lower-return categories like auto and leasing where the core yields have improved and the portfolios have decreased by more than 7%, and redeployed against higher return categories like our education refi and Merchant Finance portfolios as well as in higher return relationships in Commercial.

Additionally, we continue to deliver beyond expectations in our TOP programs where we now expect TOP IV to be at the higher end of our range and deliver $105 million to $110 million in benefits.

As we work on running the bank better, we've launched the next phase of process reengineering opportunities with a focus on consumer operations, mortgage and project delivery as we've seen some real benefits from the work so far.

For example, in Consumer Banking, our efforts to improve the new relationship experience for deposit account opening have reduced new-to-bank customer attrition, increased the net promoter score by 10 points and increased mobile enrollments by more than 30%.

And for our commercial clients, we've implemented a concierge service model, which has significantly increased the speed with which we address client requests.

We are also leveraging enhanced data analytics and transformative technology such as APIs, robotics and cloud to improve the customer experience and work more efficiently.

We have been able to use robotics and process reengineering to improve cycle times for key client processes.

For example, we've reduced onboarding times for new cash management clients by 60% since the first quarter this year.

On Slide 14, we highlight some of the longer-term investments we are funding in order to position us for sustainable success.

Bottom line, we have been able to successfully lean forward with our longer-term strategy, while also executing well and delivering strong results in the near term.

On Slide 15, you can see the steady and impressive progress we are making against our financial targets.

This quarter, we hit the lower end of our 13% to 15% medium-term ROTCE target.

Since 3Q '13, our ROTCE has improved from 4.3% to 13.5% underlying, and our efficiency ratio has improved by 11 percentage points from 68% to 57%, excluding the impact of Franklin.

And EPS continues on a very strong trajectory as well, up to $0.93 on an underlying basis from $0.26.

Our outlook for the fourth quarter is on Slide 16 and it reflects continued momentum in both our top and bottom line results.

We expect to produce linked quarter average loan growth of around 1% to 1.25%, given strong commercial lending pipelines and solid growth in education and retail unsecured, particularly with a strong showing in the third quarter Apple iPhone upgrade loans.

We also expect net interest margin to expand by approximately 3 to 4 basis points linked quarter, reflecting the ongoing impact of our BSO activities, particularly our deposit initiatives and the benefit of rising rates.

In noninterest income, we are expecting to see growth around 5% to 7%, with a strong quarter for Capital Markets given strong pipelines and some seasonality.

Also, we will see an additional lift from the full quarter impact of Franklin.

Excluding Franklin, core growth is expected to be about 2% to 4% linked quarter.

We expect noninterest expense to be up around 2% to 3% in the fourth quarter, also including a full quarter impact from Franklin.

Excluding Franklin and notable items, expense growth is expected to be around 1% to 2%, with positive leverage and further efficiency ratio improvement.

Additionally, we expect provision expense to be in the range of $85 million to $95 million.

And finally, we expect to manage our CET1 ratio to end the year around 10.8%, and we expect the average LDR to be around 98%.

In addition, we are anticipating a tax gain as we finalize the impacts of tax reform, which is expected to be largely offset by costs associated with TOP V.

To sum up, on Slide 17, our strong results this quarter demonstrate our continuing strong performance as we execute against our strategic initiatives and continue to improve how we run the bank to drive underlying revenue growth and carefully manage our expense base.

We're very pleased to have closed the Franklin acquisition and successfully launched Citizens Access this quarter.

Our outlook remains positive as we continue to work to become a top-performing regional bank.

Let me turn it back to Bruce.

Okay.

Thanks, John.

And, Brad, why don't we open it up for some questions from our viewers.

(Operator Instructions) And the first question here is going to come from Matt O'Connor with Deutsche Bank.

I was wondering if you could talk about the prospects to accelerate the share buybacks just given how weak your stock has been and obviously, the earnings and capital levels are quite strong.

I'll go ahead and start off with that, Matt.

I mean, I think that -- I think we've done a nice job this quarter of returning capital to shareholders.

As you saw in our remarks, we have returned $529 million, $400 million of that coming from repurchases.

And we like the opportunity to return capital to shareholders over time as we talked about.

We have a glide path that we are pursuing that allows us to balance not just the return of capital but also deploying that capital into growth opportunities.

We still see nice opportunities for growth, and we'll continue to monitor that over time and react accordingly in terms of how that glide path plays itself out.

I guess, within the parameters that we set, Matt, in CCAR, we did -- got more weighted earlier in the 4-quarter period, and obviously, on DIPs, we're taking in more stock.

So you can't exactly mark a time, but as you say, the stocks have, kind of, astonishing valuations at this point, so we'll take advantage of that.

Okay.

And then just separately, if you look at the revenue growth, not just this quarter but year-to-date, among the highest in the industry, and obviously, hopefully, that's sustainable.

But if it's not, do you have leverage to cut costs so you can continue to meet your targets?

Obviously, you've got the TOP initiatives and you're going to focus on the operating leverage.

But frankly, you haven't needed to maybe manage the costs as much because the revenue has been so strong.

But if it does slow, do you have the flexibility to meaningfully bring down the expense growth?

Well, Matt, I think we've had a very consistent model here to deliver that top line growth.

And so, we've got a very strong capital position.

We're growing loans prudently, I would add, by finding niches in consumer and by expanding our coverage force and overall size of our business in Commercial.

And I think there's still room to go with that.

So if you start with roughly 70% of your revenue is net interest income, and you can grow your loans, we've been able to grow them roughly 5%.

But a nice level of loan growth and an asset-sensitive balance sheet within a rising rate environment plus our BSO initiatives means that's the formula to get very strong kickup in revenues.

Then combine that with the investments we've been making in our fee-based businesses and deepening relationships with our customers, we should be able to keep growing fees, I think, certainly, in mid-single digit level ex acquisitions.

So I'm still optimistic that the formula that's worked will continue to work.

And so, if you look last year, we had 10% revenue growth, which was tops in our peer group, I think if my memory serves me.

Against 3% expense growth, we had 7% positive operating leverage.

We're probably now in a 7% or 8% top line growth, keeping expenses down around 3% so we're 4.5% operating leverage on an underlying basis.

I think the good news if you can achieve that revenue growth, you can continue to fund the investments for the future that we've made and keep your expense growth in check.

So one thing I'd point out that I think differentiates us versus peers is the consistency of the TOP programs, the relentless focus on improving end-to-end processes and customer experiences while extracting costs.

That frees up dollars so that we can hire more customer-facing people invest in the fee businesses, invest in great technology.

We were first-to-market in our peer group with online robo advising with our SpeciFi product, first to roll out the National Digital Bank.

So I think we're doing a great job.

And having that top line growth allows us the flexibility to make those investments and still deliver the positive operating leverage and still drive our ROTCE higher.

And our next question will come from Peter Winter with Wedbush Securities.

I was just wondering -- if I look out, are you seeing any letup on paydown activities or borrowers getting near the end of tapping some of this excess liquidity for growth that could lead to better loan demand next year?

Don, you want to take that so...

Yes, I'd say there's not a perceived trend.

What we're seeing is a little bit of a drop in utilization.

So we've had pretty consistently strong new business pipelines across the board all year long and we continue to see that as we look into the fourth quarter and into next year, and that's both lending and our fee businesses.

That's going to offset a little bit by what Bruce mentioned, which is a little bit more selectivity on our part, and we see terms and conditions a little bit stretched and a little bit lower utilization.

So I think that the utilization trend we don't see it changing right now, and aren't seeing a particular change in sentiment among borrowers, but we are seeing a lot of activity across the board so we continue to be optimistic around growing our business.

And then the loan-to-deposit ratio, it's 98%.

I guess, it's supposed to be stable in the fourth quarter.

Do you think that ratio could move lower next year with some of these deposit strategies that you have?

Yes, I mean, I'll go ahead and take that.

I mean, I think, the idea here is that we want to have deposits fund our loan growth and the outlook that we have now is for deposits to grow, at least as fast as we grow loans.

And so, we've seen great, frankly, take-up in our deposit growth.

And I should add that a big part of that deposit growth comes in the DDA space, which we're really pleased to be able to continue to do that here throughout 2018, consistently growing that.

And in terms of where the LDR goes, I mean, I think, we're pretty comfortable in that upper 90% range, call it, 97%, 98%, 99%, and we've been -- we've had a demonstrated ability to manage to that and feel like that's likely to be durable into the future.

And our next question will come from Saul Martinez with UBS.

First question, and I know you spent some time on the strategic initiatives, so forgive me if this is a little bit repetitive.

But where do you think you are, just more broadly, on the balance sheet optimization efforts?

And maybe to use a baseball analogy with the Red Sox going to the World Series.

What inning are you in and where do you see the most opportunity still?

Is it still in education lending?

Can you just, kind of, walk us through the various initiatives to optimize the left and right side of the balance sheet and, kind of, how much further you can go there?

Sure.

It's Bruce.

I'll start and then flip it over to John.

But if I had to put it into baseball terms, I'd say, we're still maybe only in the middle innings, fourth inning or so.

We've -- -- if you go back 3, 4 years ago, we were doing this on an informal basis.

So it was really, kind of, myself CFO, Treasurer, working with the Vice Chairman, trying to figure out which way we needed to tilt capturing deposits, regaining our deposit market share, after under RBS the balance sheet had shrunk and we needed to reflate the balance sheet.

That was pretty easy pickings.

And so, Commercial really was going out, doing the heavy lifting, getting the deposits back on the balance sheet.

But as times moved by, we thought the success we've had with TOP, we could try to replicate and put in place a more formal BSO program where we'd have specific initiatives on the left side of the balance sheet and the right side of balance sheet with actions that would be monitored, ownership, et cetera, same kind of structure that we have running TOP.

And so, I think we're making traction.

On the asset side, we are running down certain portfolios.

So you can see auto is running down, leasing is running down, those are not credit concerns.

Those are simply not a good use of capital.

We're not making the returns that we would like there.

And then, you saw us make a loan sale in the second quarter out of corporate.

And so, I think we've got to be very disciplined.

If we're not getting deeper relations in cross sell, then we have to exit credits, and we can do some of that naturally, but we can also bunch some and sell them.

So those have been the, kind of, minuses.

And then, growth has really focused on consumer trying to find attractive niches.

Education refinance, we were one of the pioneers of that market.

It's still a very attractive market.

The upgrade program we have with Apple and merchant financing at point-of-sale, that's another very attractive area.

We have another relationship and another one coming soon.

And so, we're excited about that.

So we'll continue to push into areas where we see opportunities.

On the Commercial side, I think we've built out our industry verticals, so we could go upmarket a bit into the Mid-corporate space.

Those tend to be full relationships where we can get a good share of wallet so we're seeing some nice traction there.

In Commercial Real Estate, we really had become very underscale in RBS -- under RBS ownership because they were running off Commercial Real Estate exposures globally.

So we've really just been regaining our market share and again being very, very selective about where we're playing.

In fact, we -- I should point out, we have a fellow who used to run Workout is running Commercial Real Estate.

And with Don and his acumen, I feel really good about what we're doing in Commercial Real Estate.

On the right side of the balance sheet, again, we wanted to have more tools in the toolkit, so we launched Citizens Access, which is off to a fantastic start.

It's exceeding all of our metrics that we set out at this point so very pleased with that.

We have noticed that in Commercial, we're not always playing with a full tool set there as well.

So we're investing in having full escrow capabilities, bankruptcy capabilities.

There's a new cash management platform we're rolling out.

So we want to gain a bigger share of natural deposit relationships, which should come with less pricing pressure.

So those are a few of the things, I feel, they're still -- one of the great things about Citizens is we've been a self-help story and if something's not great, that's a good thing because that means we can fix it and then continue to propel our earnings higher.

Let me go around the horn here and see if anybody wants to add to that.

It was a long-winded answer so I don't want to take the whole call on it.

But, John?

I'll just add, just a high-level point or 2. That was well -- of course, well covered.

And I think, I just would highlight the fact that year-over-year net interest margin's up 15 basis points and 5 basis points of that comes from BSO.

And so even without rates, we remain self-help on -- in the net interest margin space and that's good.

And I think, we've got a lot of room to run there.

We're still about, call it, 10 or 15 basis points short of peers in terms of net interest margin.

And one of the places that manifests itself is in noninterest-bearing deposits, where about 25% of our deposits are in the noninterest-bearing space.

We continue to grow that space because we're making up ground that -- since the IPO, and you could see that getting over time north of 30%, that's really our target is to get north of 30%.

And all of the initiatives that we have in place in the Consumer side and Commercial side, which I won't go into in too much detail but investing in data and analytics, increasing our market spend back to peer levels, our product offerings in Commercial, REIT platform and the cash management business will all support that engine of net interest margin growth over time.

Yes, sorry.

Brad, you want to -- just let Brad.

Yes, I was just going to add one other thing and it really ties into what you guys are saying.

One of the positive stories for us has been our ability to grow DDA and low and no-cost deposits.

And part of the reason for that goes back to, Bruce, what you were saying is, we were underweight.

We have a very attractive -- we were not getting our fair share from our own customer base.

So we had a -- we have a very attractive affluent customer base, and we weren't getting our fair share of their low-cost deposits.

And I think with all the initiatives we have around rebuilding the value proposition for our affluent customers and then the investment we're making in segmentation and targeting, that gives me a lot of confidence we can continue to grow.

We can outpace the growth of those low-cost deposits.

That's great.

If I could follow up on regulations.

We should get proposals on S.2155, I would think, fairly soon.

And if we do move to a -- more of a prudential regulatory -- prudential standards that are based on complexity versus risk.

Does that change at all how you manage capital and liquidity, specifically on capital, could it help trigger at least a rethink of the 10% to 10.25% CET1 target potentially going lower?

Well, look, I think we have always said that our risk profile is certainly no worse than median.

In fact, we think it's slightly better than median.

So there's no reason over time for us to carry a capital surplus versus the peer median.

So most peers are professing that they're going to move down, that they think they have plenty of capital to safely run the bank.

And so we'll calibrate off of that.

So if the peer median moves down, we'll move our goalpost down.

But I think the nice thing of the rethink on the kind of bracket we're in under 250 is that it would just increase flexibility around decisioning.

So just like Matt said earlier in one of the first questions on the call today, now that the stock prices of regional banks and ours in particular have washed out, would you maybe want to buy more stock?

You have to go through a process today, the way CCAR works, that you would probably gain some new flexibility based on the rethink that's taking place.

Anything, John?

Yes, yes, I think that's exactly right.

I think flexibility on the capital side increases.

I'd say, that occurs either with S.2155 or with the SEB.

Both of those things, or either of them actually, would allow for that flexibility and would allow us to balance RWA deployment against capital return much more effectively.

On the liquidity side, a little bit less of an impact, I mean, we tend to run ourselves in a conservative way in terms of our internal models with respect to that.

And so from that standpoint, I think capital's may be the bigger impact versus liquidity.

And our next question will come from Brian Klock of, I believe it's Keefe, Bruyette & Woods.

So a bigger picture question.

I guess, first for you, Bruce.

The progression and profitability and expansion profitability has been the best in the group.

And if you think about you're above the lower end of your 13% to 15% ROTCE guidance range.

I guess, is there a thought process maybe so you enter into this year-end planning process and for next year that -- would that be an opportunity to think about updating that?

And how do you think about maybe moving that up since you guys have executed pretty well here?

Yes.

So look, we're quite pleased that we've run ahead of pace to get into that 13% to 15%.

We're certainly ahead of the budget for the year, and I think our coming into the year consensus has been taken up about 10%.

So it again reflects very good performance throughout the year.

We typically look at all of the metrics and the targets at year-end when we put our budget to bed.

And then on the January call, we'll give you detailed guidance for '19 and then potentially look at whether we want to refresh those medium targets.

I think the thing that everybody is aware of is that as you get farther into the expansion, at some point, you'll have credit costs rise and start to normalize, which would create some headwinds against PPNR.

But at this point, we feel good.

I mean, we feel good about the economic outlook for '19.

We don't think any recession is around the corner.

I feel good personally through '20.

At this point, we don't see the buildups and the excesses that you would start seeing if you were getting closer to a recession.

So, anyway, we will take all that into account when we consider whether we're going to move the 13% to 15% higher.

That's great, that's good color.

And maybe to follow up on some questions and discussions on the NIM earlier.

And, John, I just wanted to just double check that.

The NIM expansion, the guidance for the fourth quarter.

So that would include, obviously, the impact of the good growth from Citizens Access, which does come in at a higher deposit beta and then even the impact of the FHLB advances.

Was that through the $2 billion as long-term borrowings increase and on a spot-to-spot basis?

Was that from FHLB advances in that increase?

I think there -- what you're seeing there, maybe I'll just take the deposit part of it first in the context, and then I'll cover borrowings.

But that does include, in the fourth quarter, the impact of Citizens Access going from $1 billion to $2 billion.

Really, what that does is it basically balances and optimizes our promotional activities across the whole platform.

So as we're profitably supporting the loan growth in the fourth quarter, we can do that in a much more efficient way with a combination of our in-footprint activities connected with Citizens Access trajectory.

So that's all included and is beneficial to the NIM in the fourth quarter.

As it relates to borrowings, yes.

I mean, Borrowings are up on a spot basis.

On an average basis, they're pretty flat over the last couple of quarters going into the third quarter.

You may be seeing an increase in spot that occurred just in terms of the natural variability that you've seen in commercial deposit flows.

And so at the end of the quarter, you have some deposit flows out they come back in and that's really what you're seeing, not really a signal that, that is headed north in a significant way.

All right, great.

And maybe I can just squeeze one more in.

One of the things that you guys have done this quarter which you've, kind of, bucked the trend for the industry this quarter and for the full year, for that matter, is have DDA growth.

I know you mentioned even excluding the First American mortgage escrow deposit that's up quarter-over-quarter and year-over-year.

So maybe you can just highlight the fact that to me, it sounds like that's growth in customer accounts.

And I think, Brad, you commented on that too, but it does seem like to me that's commercial customer accounts too that you're growing.

So maybe you can just talk about how you guys are executing better than the rest of the industry as on DDA growth?

Yes, I'll start with that.

And it's really a combination of deepening with our existing customers and new household growth.

So we've got good strong household growth and part of that is the investment we've made in data and analytics, which allows us to spend more on marketing to acquire customers.

And then -- and I mentioned this in my comments earlier, we've long had a very attractive household base at Citizens, very steep in mass affluent and affluent customers.

And we really haven't gotten our fair share over time of their low costs, their DDA deposits.

And a lot of the work we've done in the last year or 2 is really we worked very hard on the value proposition, we launched our new Platinum value suite, a lot of segmentation work around building the right value proposition.

And that has allowed us to grow our DDA balances with our existing customer base.

The last point I'll make, and then I'll turn it over to Don, is just -- to that point of household growth, I do want to make the point that's been very, very high quality household growth.

So our primary household relationship, our mobile active metrics are some of the best we've ever had.

So it's not only good household growth but it's primary and active households.

On our side, I'll just add, Bruce mentioned the investments we're making in our cash management business.

And that goes really from the product level all the way through to the service level, and it's allowing us to add business on our [credit] services platforms and that should accelerate as we roll out the new platform in 2019.

Your next question here will come from Ken Zerbe with Morgan Stanley.

With Citizens Access, obviously, off to a really good start, and I know you're targeting the $2 billion by year-end.

But I guess, the question is how do you stop that growth?

Because I just went online, I saw you're offering 2.12% on savings accounts.

So like how do you get people to not continue to go into that product?

Well, I'll start and, Brad, you chirp right on it.

But it's a very elastic market with respect to pricing.

So you can turn the dial up or down based on where you are, kind of, in the forced ranking of those offerings.

So that's one thing, Ken.

If you wanted less deposits from that channel, you could just drop your pricing and it will kind of go to the level that you want.

So that's one thing.

But what I would say more broadly than just, kind of, competing on rate.

I think one of the reasons we've been so successful is that we've really, really focused on delivering a great customer experience, which we try to do with everything, but I think we've really nailed it here that you can go online, Ken.

We'd be happy to have you as a customer but you could -- after this call, you could get on our website, open and fund an account in under 5 minutes.

That's basically proven.

So it's really a great, easy-to-use experience and ability to get reporting on what you got and some nifty stuff.

The other thing that I think we've done exceptionally well is I think we have really regional peer-leading data capabilities.

And so, we've put that to work to target households and keep our overall account acquisition costs quite low.

And so that's part of the equation as well.

So it's really your functionality, where you are on the pricing ladder.

And then your account acquisition, your data capabilities that determine your success factor, and I think on all those dimensions, we've pegged it almost perfectly.

Yes, Bruce, I agree with all that.

And one other point that I would make is, if the question is, sort of, around this concept of cannibalization or are you just going to continue to encourage your own customers to take the higher-cost offers?

The answer is, we're getting 75% of our customers out of footprint.

So this has given us a national capability.

So 75% of our customers coming in are out of footprint and only 3% are coming from our own customer base.

So this is a whole new customer segment that we're attracting, that we weren't reaching because they're not traditional branch users.

And I think it also gives us just more confidence around.

It's almost a petri dish to improve our digital and data capabilities, which is only going to help us in the long run with our core franchise as well.

Got it, understood.

And I understand you can drop the rate on.

I guess, that presumably implies the customers are pretty much hot money customers and you're going to lose the customer so they are -- I mean, maybe -- is the right way to think about these -- this customer base more like wholesale borrowings to some extent, like...?

No.

Not at all.

No, no, no.

Let me jump in.

It's John.

I think just throwing some numbers out there just to give you a sense of where we are.

So after the last rate hike, we did -- we lagged our rate rise.

And so it's not just dropping rate, but it's also lagging rate.

There's a customer experience part of this story and there are product enhancements in future phases of this platform that we're going to invest in to deepen the relationships.

This is not intended to be a one-and-done launch.

And so you will see more buildout in a test-and-learn way using this as the backbone of a digitally savvy channel that serves an incredibly attractive customer segment that we want to learn more about how to serve.

So again we lagged the last 25 basis point rate rise from the Fed, we rose by 12 basis points.

On the next Fed hike, we'll take a look at what makes sense there.

And it's clearly a very efficient way, lower-cost channel that is superior to wholesale funding.

And I think the -- Ken, the stress test assumptions around that and really would say that this is analogous to just your own affluent customers.

If you have a lot of cash, you care more about the rates that you're getting.

And so in our core customer base, the folks who of means are going to try to make sure they're getting a good rate on deposits and that's really all this is.

The average account size, as John indicated, was $70,000.

So these are relatively affluent customers.

And we have Scott Siefers with Sandler O'Neill.

I think most of my questions have been hit.

I guess one though is on the fee guide, John.

So it's a little, actually, quite a bit stronger than I had anticipated.

I know you mentioned in your prepared remarks Capital Markets should be a good quarter, but I wonder if you can just spend a moment or 2 talking about, sort of, what's going well, what's not going as well as you had hoped as you look at that fee guide into the fourth quarter and beyond?

Yes, I'll go ahead and start and then maybe Don can follow up.

In the outlook, Cap Markets and Global Markets are both expected to be drivers.

But really, a lot of our fee categories are contributing to our expectations for 4Q including service charges.

And frankly, onesie-twosies across several of the other categories including investment and trust.

So in the cap market space, our pipelines are strong.

That's the business that you have to monitor, the external environment very closely because of the ebbs and flows there.

And we've probably made a lot of investments and capabilities there and in Global Markets that's providing that lift, and I'll let Don elaborate.

Yes.

So I'd say that's all correct, and we go back to where -- what John said in his remarks as being the syndication lending business was quite weak in the third quarter.

It was due to market downdrafts across the board.

We're seeing that come back in the fourth quarter.

I will also say the M&A business is kicking in as we begin to benefit from Western Reserve now that we're 1.5 years in.

So those, obviously, transactions take a long time to mature, but we're beginning to see transactions lined up to close in the fourth quarter.

And then, Don, Global Markets, which is FX and interest-rate risk management, we've built a great team.

We've got a great platform, and we're expanding our capabilities.

We're now offering options capabilities.

So some of the things that we had to stand up as we separated from RBS.

We've now got those in place and we're gaining traction there.

Yes, I think that's important.

I think that you have to realize a lot of these businesses we're 2 or 3 years into.

And it takes a while to build the products, build the team, and then get out in front of the client base and market them, and I think the number of wins we're achieving across the board is quite encouraging.

Yes.

And we'll go to the line of Erika Najarian with Bank of America.

I just had one follow-up question.

Given your strengths in lending trends, I was wondering if you could give us your perspective on how nonbank competition has potentially accelerated in the businesses that you have been expanding in.

And how, sort of, the structure and the rate offerings are -- differ from that of the traditional banks?

Yes.

So obviously, the growth of the nonbanks has been something that we've been dealing with for years.

I go back 25 years ago when we began to sell risks to nonbanks when the old HLT designation came in, in the commercial banking industry.

But we see it in twofold.

Obviously, they are competition but they're also a distribution channel for us.

So we originate a lot of leverage risk and sell it to the nonbanks as part of our distribution efforts.

And our strategy in leveraged finance is to hold very little of the originations that we undertake particularly with sponsors.

So our hold levels versus our volumes are quite low.

So we view them as a different type of competitor.

They don't have some of the same accounting challenges we have as banks or some of the ratios that we need to manage through.

But we -- I don't see them as a massive limitation in terms of the ability to continue to grow the business.

Yes, and on the consumer side, I would say there's 2 asset classes where we're seeing the nonbanks compete.

One is on personal unsecured lending PERL, what we call PERL.

And the other is education refinance.

And we -- particularly in the personal unsecured space, we've seen the nonbanks be pretty aggressive there.

I think the big differentiation between us and the nonbanks is they're playing in a lower credit profile than we are.

So we've maintained our discipline of staying really up in the high prime space, and we're seeing our competitors go down credit.

Got it.

And just -- oh, I'm sorry, didn't mean to interrupt.

No, that's fine.

Go ahead, you have another one?

Yes, just one -- just a follow up.

Could you help us size the residual risk that is on the balance sheet?

And also, do you have any term exposure on any sponsor backed transactions that you do keep?

We have about 2% of our assets in sponsor leveraged finance right now.

So it's relatively small.

Some of it will be term.

That's the commercial.

At the commercial, so some of it will be term, some of it will be revolver.

We kind of play in maybe a 5-year, kind of, maturity bucket on the pro rata side.

And your next question in line will come from the line of Lana Chan with BMO Capital Markets.

Just a quick question.

Have you given an estimate on terms of the FDIC surcharge savings going into next year?

No, we haven't done that, but we're very much looking forward to it because it is a attractive number.

So stay tuned.

We'll probably -- that will be in our guidance when we do that in January.

You want to offer something, John?

Yes, I'll just mention it.

It's about $15 million a quarter for us and it's anybody's guess when it will actually end.

I think the general sentiment is that by the end of this year, we'll go ahead and stop the surcharge from being applied.

But it's $15 million a quarter, and we'll, as Bruce said, we'll build that in to our outlook as we consider how we want to make investments and drive profitability into 2019.

Okay.

And just a follow-up on the securities book.

I mean, with the backup of the long end of the curve recently, does that change how you view securities deployment or investments opportunities?

No.

I mean, I think, securities portfolio is primarily a liquidity store as we try to manage against LCR and our internal view about liquidity stress.

It also helps us moderate our interest rate risk exposure.

Those are the top 2 reasons.

And then we attempt to ensure that we're doing that in the -- with -- in the lowest cost way with the highest profitability.

In the third quarter, I think, front book yields were about [3 50, 3 60].

Runoff yields were about [2 45] or thereabout.

So you're going to see continuing improvement in that book if the long end continues to behave as the way it's been behaving.

So that's a good trend for us.

And our next question will come from Gerard Cassidy with RBC.

Can you share with us clearly, as you've already discussed about your capital levels being very strong.

One of the largest mortgage originators out there, Wells Fargo, indicates that there is excess capacity in mortgage banking -- residential mortgage banking.

Now that you have Franklin, are there opportunities to make other acquisitions to build up even more economies of scale?

And if so, do you, kind of, have to wait until you integrate Franklin before you could do something?

I think Franklin was the silver bullet that got us where we needed to be in mortgage.

So I wouldn't see us stepping out and doing any more acquisitions in the mortgage space.

Having said that, I do think there will be consolidation in the industry.

There'll be marginal players that are driven out of the business given where gain on sale has moved.

And that bodes well for the scale players.

So I think we should benefit from that trend.

Agreed.

Good.

And then -- and second, when you look at optimizing your balance sheet and when you get it to the level where it's optimal.

Where do you think -- I know ROE is the function of the denominator equity, of course, and the numerator.

But when you look at it from an ROA perspective, some of our best regional banks have ROAs that are in the 160s, 170s.

What do you think, in an optimal environment, your ROA could get to?

I guess, we haven't focused that much on that metric, Gerard.

I think we've continued to see that move higher, as we've run the bank better.

We have -- you'd have to consider where you are in the cycle and your business mix.

And so, I think our focus has really been on ROTCE.

We mentioned earlier, we're currently targeting 13% to 15%, we're now in that range.

I think if we continue to run the bank well the way we've run it, and we can keep delivering operating leverage and get the balance sheet optimized, there's certainly room for those metrics to move higher.

I think that would imply, I mean, it's just the math associated math that, that would imply that we would get to the mid-1s or thereabouts.

And when you get to the mid-teens on returns, you're basically talking...

You can do the reverse math but our focus has really been on the ROTCE.

Yes.

And our next question comes from John Pancari with Evercore.

On the margin side, just wanted to get your updated sensitivity for an increase of 25 basis points by the Fed.

What would that equate to in terms of your expected margin benefit at this point?

Yes, I think that would be in the -- on a parallel shift, which is really the issue there.

I mean, on a parallel shift, you're in, call it, $10 million to $15 million range in the first quarter and it compounds thereafter closer to around $15 million.

In a -- in the short end, our sensitivity is about 75%.

So we get most of the benefit even if the long end does not rise.

The stat that we quote typically has been to a gradual 200 basis point rise what would be the impact there.

And I think last quarter, that was high 4s.

I think we're actually trending up a little bit towards the mid-5s.

Some of that is just fine-tuning our models.

But we've kept the asset sensitivity reasonably stable.

We think that's the proper position to have in a raising rate environment.

So we'll continue to benefit as the Fed lifts rates.

Okay.

And then, also on the NIM.

Is that 5 basis points of structural upside here NIM annually that you see from the balance sheet optimization.

Is that still intact?

It that still around 5 basis points?

Is that still your outlook?

Yes.

Yes, we've said that previously that without rates, we're looking to get somewhere in the neighborhood of approximately 5 basis points.

And then on a year-over-year quarter basis, this quarter, I think...

We got 5.

We got 5 out of a 14 so I think we're trending towards that this year and we can update that as part of our guidance for next year in January.

Got it.

And then lastly, for Don, what -- you mentioned the -- that you do lead a good number of leverage transactions but you syndicate a lot of it out.

What percentage of your leverage deals that you syndicate, are you in the lead position?

And then, what is your average hold level?

I'd say, our hold level is in the $10-ish million range.

I don't have the exact number, so I'll call it $10 million, so relatively small.

We play in a lot of deals that are $300 million to $400 million in size.

So that will give you a sense.

I think the general rule, in my career, has been, you want to hold less than 5% of the risk you're originating.

So that's what we try to do.

And I'd say, we're probably leading about 65%, 70% of the deals, either as the lead or the joint lead.

And our next question will come from Kevin Barker with Piper Jaffray.

In regards to some of the movements around the liabilities, we noticed that wholesale deposits went up quite a bit this quarter.

Now some of it could be seasonality and how you're funding your balance sheet specifically at period end.

Given that Citizens Access has come on board and you should see an acceleration in deposit growth there, do you expect wholesale deposits to decline in the fourth quarter or was there some seasonal aspect that you would see a shift between your interest-bearing deposits and your wholesale funding?

Yes, I think on the wholesale side, we tend to see that relatively stable.

Where the trade-off is at least in the near term on Citizens Access is, as we're trading off promotional activities that might otherwise have occurred in the businesses, in the branch businesses, that we can do more efficiently through Citizens Access.

So there's a little bit of a trade-off there.

And sure, at the margin, you might find a little bit of a impact on the wholesale.

But that tends to be structurally a bit stable and will be in place over the near term.

Right.

And then when you think about your fee income going forward, do you expect Franklin to continue at this rate with the margins that they are generating, given the capacity constraints within the mortgage industry beyond the expense saves that you've already laid out?

Yes, I'll start off with that, and maybe Brad will add.

But the -- yes, I mean, margins are down in the industry for both our legacy Citizens business and -- which we've seen, and we've seen that in the data that came over in the history for Franklin.

I think we're -- there's 2 forces there that are going to correct that.

One is, we are endeavoring to get much more efficient and take capacity out ourselves, which Brad can talk about, and, therefore, to offset that decline in revenue due to margin by being more efficient on our platforms.

And then, as Bruce mentioned earlier, the other participants in the marketplace, there's some nonbank players that just aren't going to make it and we expect that the capacity will come out.

Therefore, you'll see margins stabilize a bit over time.

It's just the natural ebb and flow of the mortgage market.

But I'll stop there and see if Brad has anything else to add.

Yes, really not much more to add, to be honest.

I think you said it right.

We would fully expect and we're already starting to see it with the competitors taking capacity out and that will have the natural balancing impact of bringing margins back to a more normal level.

And in the meantime, we'll be very, very disciplined about expenses.

Yes.

Look, I would just add, it's Bruce, that we're very excited about this acquisition that it really gets us the scale that we needed.

It diversifies our origination channels.

It's a real quality operation with great technology.

We're going to keep moving aggressively to better customer experience and digitizing front-end origination.

We've got some great plans in the business.

And so we have high hopes for the business.

And if the market's a little soft, that -- we'll work our way through that.

But this is something that we wanted to be in.

We think it's an important product capability that we need to offer to our consumer customers on their life's journey where we can be their trusted adviser and help them go through a very big personal transaction for them.

And now I think we're in the business with the right scale in the right way.

And there are no further questions in queue at this time.

With that, I'll turn the call over to Mr. Van Saun for closing remarks.

Okay.

Well, thanks again for dialing in today.

We appreciate your interest and support.

I think there's a great opportunity to make money in this stock, I'll just add gratuitously.

We continue to execute well and we maintain a positive outlook for the fourth quarter.

So have a great day.

Thank you.

And that concludes today's conference call.

Thanks for your participation.

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