Citizens Financial Group Inc (CFG) 2019 Q2 法說會逐字稿

Good morning, everyone, and welcome to the Citizens Financial Group Second Quarter 2019 Earnings Conference Call.

My name is John, and I will be your operator today.

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

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

Ellen, you may begin.

Thanks so much, John.

Good morning to you all.

We're really pleased to have you join us.

We've got a lot of great material to cover in our presentation, which you can find at investor.citizensbank.com.

First, this morning our Chairman and CEO, Bruce Van Saun; and John -- CFO, John Woods, will walk through our results and our outlook, and then we'll be happy to take questions.

Brad Conner, Head of Consumer Banking; and Don McCree, Head of Commercial Banking, are here also to help us with that effort.

I need to remind you that our comments today will include forward-looking statements, which are subject to risks and uncertainties, and you should review the factors that may cause our results to differ materially from the expectations on Page 2 of the presentation and our 2018 Form 10-K.

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

And with that, Bruce, you've got the floor.

Okay.

Thanks, Ellen.

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

We're pleased to announce another strong quarter today.

We navigated reasonably well through a dramatic change in the rate environment.

Our fee businesses have really come on strong as we've integrated well our recent acquisitions, and we're able to do more for our customers.

And our expense discipline continues to be excellent.

We continue to find efficiencies that lead to simpler processes and better customer experiences, while also creating the wherewithal for funding new growth initiatives.

We're also very focused on being good stewards of our shareholder capital, both in terms of loan growth and capital returns to shareholders.

Our year-over-year loan growth was 4% with a lot going on inside that number.

We are allocating capital to grow portfolios that offer good risk-adjusted returns and attractive cross-sell, while extracting capital through loan sales and runoff as part of balance sheet optimization.

We are passing on commercial deals in the market where we don't like the risk, the terms or the pricing.

Our deposit growth has been faster than loan growth at 7%, which has the benefit of bringing our loan-to-deposit ratio down to 94%.

Citizens Access has been key to this as they reached $5.4 billion in deposits by quarter end.

This lower LDR gives us increased flexibility on funding strategies, which will be highly beneficial in the current uncertain rate environment.

We recently announced a 25% increase in our buyback capacity to $1.275 billion.

And today, we announced a $0.04 dividend increase to $0.36 per share, with dividends now up 33% from the year ago quarter.

I'm excited by the work we've done in developing a significant TOP 6 program and also in some of the strategy work around investment opportunities to drive medium-term revenue growth.

I'll let John take you through the details on our slides.

But to me, these programs are well designed and should deliver real benefits if executed well.

We want to be innovative, nimble and flexible in how we operate.

We want to up our game even further in how we deliver for customers, and we want to break through on some new revenue pools.

All very exciting and differentiating versus peers.

Our strong first half performance with EPS up 14% reflects our disciplined operating mindset and capability as we've had to grind out results in a tougher environment than expected coming into the year, particularly around the extreme movement in rates.

I think we're well positioned for the second half with strong fees and expense discipline poised to offset rate pressure in NII and credit still in very good shape.

We will continue to focus on disciplined execution.

You can count on that.

So let me stop there, and I'll turn it over to our CFO, John Woods.

Thanks, Bruce, and good morning, everyone.

We are pleased to report another solid quarter with good fee income growth, strong expense discipline and consistent execution against our strategic initiatives.

Let me kick off by covering important highlights of our underlying results.

On Page 4. We delivered EPS growth of 9% year-on-year, with PPNR up 7%.

Despite a challenging rate backdrop, we delivered net interest income growth of 4% year-on-year.

Loan growth was 4%, and net interest margin was stable at around 3.21%.

We also continued to drive momentum in fee income with 19% growth year-on-year, 6% ex acquisitions, highlighted by record results in mortgage, Wealth, Capital Markets and card fees.

Our disciplined focus on growing the top line and controlling expenses drove positive operating leverage of around 1% before the impact of our recent acquisitions.

Commercial Banking loan growth was 7% and Consumer Banking loan growth was 3% as we continue to find attractive areas to deploy our capital and grow our customer base.

Strong deposit growth was paced by continued momentum in Citizens Access.

Our spot LDR improved to 94.2%, providing us with funding flexibility as we head into the back half of the year.

Overall, credit quality remains excellent with a stable nonperforming loans ratio of 66 basis points and an allowance-to-loans ratio of 1.05%.

We delivered underlying ROTCE of 12.9% and tangible book value per share was up 12% year-on-year and up 4% linked quarter to $30.88.

We finished the quarter with a strong 10.5% CET1 ratio.

On Page 6, net interest income was up 1% linked quarter as asset growth and the benefit of day count were partially offset by a 4 basis point decrease in NIM given rate impact.

Importantly, we have taken significant steps to reposition the balance sheet profile in a lower rate environment.

During the quarter, we opportunistically used hedges to reduce our asset sensitivity from 4.2% to 2.9%.

We shifted the vast majority of our sensitivity from the short end to the long end of the curve with 75% of it tied to rates longer than 6 months and about 25% coming from the short end of the curve.

This action was the most recent step in a program that began in the third quarter of 2018 to moderate our asset sensitivity overall.

This was driven in part by increasing our net receive-fixed swap position over 50% from around $9 billion in the third quarter 2018 to $14 billion in the second quarter 2019.

Moving to fees on Slide 7. As I mentioned, we delivered strong execution in our fee-based businesses, highlighted by record results in mortgage, Wealth and Capital Markets as we continue to build out our capabilities and deepen client relationships.

Noninterest income was up 8% on a linked quarter basis and up 19% year-over-year.

Before the impact of acquisitions, noninterest income was up 3% linked quarter and up 6% year-over-year.

In commercial, Capital Markets fees were up 19% year-over-year and up 6% linked quarter.

Despite the slower market conditions, our businesses continued to perform extremely well, paced by a record number of deals in loan syndications, which were up 73% linked quarter.

FX and interest rate product revenues were relatively stable with record first quarter level, despite the backdrop of uncertainty that caused many clients to delay hedging.

On the consumer side of the house, wealth fees were up 13% linked quarter driven by higher sales volumes and an increase in managed money balances.

Card fees were also a record for the quarter, up 8% sequentially driven by higher purchase volumes, including seasonal benefits.

In mortgage banking, we saw a nice rebound in the quarter, up $19 million or 44% linked quarter driven by an $18 million increase in production revenue reflecting seasonally higher originations and a pickup in refi activity.

Servicing revenue was broadly stable given the benefit of hedges.

In addition, we continued to grow the servicing portfolio which is now over $90 billion.

Turning to Page 8. Underlying noninterest expense was up 1% linked quarter, reflecting strong cost discipline with the benefit of our TOP program initiatives.

Salaries and employee benefits were relatively stable as seasonal reductions in payroll taxes and 401(k) matching costs were largely offset by higher revenue-based incentives, consistent with the strong fee revenue trends in the quarter, the results of a $3 million severance charge.

Outside services increased 7% linked quarter on an underlying basis, reflecting our continued investments in technology as well as cost related to higher consumer loan and deposit origination volumes.

Let's move on to Page 9 and discuss the balance sheet.

You can see we continued to grow in commercial with a focus on our geographic and Industry Verticals expansion strategy.

In Commercial Real Estate, we are selectively seeing attractive risk-adjusted return opportunity with growth tied to high-quality projects, largely in office and multifamily.

On the retail side, we also continued to drive growth in attractive risk-adjusted return categories like education refinance and unsecured, including our merchant partnerships.

Overall, loans were relatively stable linked quarter and up 5% year-over-year.

These results reflect the planned runoff in auto, noncore and leasing as well as some modest headwinds from greater-than-expected asset dispositions tied to our balance sheet optimization initiatives.

Loan growth was 0.4% adjusted for the impact of 1Q '19 and 2Q '19 loan sales, with commercial up 0.8% and consumer up 0.3%.

Going forward, we will continue to elevate loan sales as part of our balance sheet -- evaluate loan sales as part of our balance sheet optimization initiatives.

Moving to Page 10.

We're doing a nice job of growing deposits, which were up 2% linked quarter and 7% year-over-year with stable results in DDA.

We continue to benefit from our Citizens Access digital platform, which has contributed nicely to our funding diversification and the optimization of our deposit levels and costs.

At the end of the quarter, we reached $5.4 billion in Citizens Access deposits.

Our total deposit costs were well controlled despite strong growth, up 3 basis points linked quarter, a significant improvement from the 16 basis point increase last quarter.

This reflects a proactive approach to deposit pricing as we have been aggressively managing our deposit costs.

We reduced CD rates and money market rates in our branch footprint as well as taken down the savings and CD rates in our digital bank.

Year-over-year, our loan yields expanded 37 basis points, reflecting the benefit of higher rates and the impact of our BSO initiative.

Our total cost of funds was up 33 basis points, reflecting a shift towards a more balanced mix of long-term and short-term funding and higher interest rates.

Next, let's move to Page 11 and cover credit, which continues to look quite good, reflecting growth in high-quality retail loans and an improved risk profile in our commercial portfolio.

The net charge-off rate of 36 basis points was up modestly linked quarter from relatively low level and included a $9 million increase in commercial charge-offs.

This was largely driven by a couple of idiosyncratic losses as the broader portfolio looks very good, with continued improvement in risk ratings and a continued lower trend in criticized and classified loans, which were down 4% linked quarter and 19% year-over-year.

Provision for credit losses of $97 million was up from prior quarter and prior levels reflecting a higher charge-off.

Our allowance-to-loans-coverage ratio remained relatively stable, ending the quarter at 1.05%.

The NPL coverage ratio was relatively stable at 159% as we saw improvement in NPLs and runoff in the noncore portfolio.

On Page 12, we've maintained our strong capital and liquidity position, ending the quarter with a CET1 ratio of 10.5%, which compares well with peers and gives us excellent financial flexibility.

As you know, we recently announced a new share repurchase authorization under our 2019 capital plan of up to $1.275 billion and this presents -- represents a 25% increase over last year's authorization.

We also increased our quarterly dividend by 13% to $0.36 a share, which reflects a 33% increase from a year ago, and we continue to target a dividend payout ratio of 35% to 40%.

Our planned glide path to reduce our CET1 ratio remains on track.

On Page 13, I want to highlight a few exciting things that are happening across our bank.

First, we are extremely proud to have been ranked #3 of the top 40 banks in the country for our reputation among consumers in the 2019 American Banker/Reputation Institute Survey.

Note that we moved up 12 positions, the largest move of any bank, which is a real testament to what our colleagues do every day to help our customers reach their potential.

Next, we've launched a suite of digital tools that transform the end-to-end mortgage customer experience and help us operate more efficiently.

In commercial, we are pleased to introduce accessOPTIMA, our best-in-class, cash management platform that is now available to new clients.

We are migrating current clients to the platform over Q2 to Q4.

Let's move on to Page 14.

The Tapping Our Potential, or TOP, programs have been instrumental in driving efficiencies that allow us to self-fund investments and continue to deliver future growth.

We have executed very well on the TOP V initiatives, which are expected to deliver $95 million to $105 million pretax by the end of 2019.

We are now pleased to share some of the early details of our TOP 6 program, which will consist of 2 parts: the first being the transformational program, which is designed to transform how we operate and deliver for customers and colleagues.

We aim to deliver a more customer-centric, efficient and agile environment by modernizing our cross-organizational operating model and IT practices, by accelerating migration to the cloud, by more ambitiously utilizing data and artificial intelligence and by digitizing end-to-end processes; the second part will consist of a more traditional TOP improvement program, similar to those that we have successfully executed over the last 5 years.

Importantly, the benefits of the program will help to mitigate the headwinds from interest rate, maintain our commitment to delivering operating leverage and improving our efficiency and ROTCE.

We also expect to utilize some savings to fund the net P&L investments of up to $50 million over 2020 and 2021 for potential strategic revenue opportunity such as: significantly expanding digital strategies across the company to reach more customers; reinventing the payment experience at point of sale; and launching new commercial customer digital offering.

We are developing detailed plans for each and will keep you posted as we make progress.

These investments should really benefit our medium-term revenue growth over 2022 to 2025 if executed well.

On Page 15, we provide additional details around the focus of the TOP program, including early days financial targets.

We are targeting run rate savings from the transformational program of $100 million to $125 million by year-end 2020 and savings of $200 million to $225 million by year-end 2021.

The traditional program is expected to deliver $75 million to $100 million by year-end 2020 and over $100 million by the end of 2021.

The combined total is $300 million to $325 million in run rate benefits by the end of 2021.

Note at the bottom of the page, the TOP 6 is expected to create the capacity to absorb some of the startup cost for those strategic revenue initiatives.

We've some really bold ideas, so we'll have to sync the level of investing with the near-term external environment.

We also point out that there will be onetime cost associated with that program, though the payback is highly favorable.

Note also that we do not expect to announce a TOP 7 next July.

We currently will leave TOP 6 open and add to it as we go over the next 2 years.

Our outlook for the third quarter is on Page 16, and it reflects continued disposition for both our top and bottom line results.

We expect net interest income to be broadly stable in Q3 as modest loan growth should offset the NIM contraction due to rates.

We are expecting noninterest income to be up modestly, similar to the trend we saw in the third quarter last year.

Given our continued focus on expenses discipline, we expect noninterest expense to be broadly stable.

Additionally, we expect provision expense to be in the range of $100 million to $105 million.

And finally, we expect our CET1 ratio to be broadly stable.

Regarding our full year outlook, notwithstanding the meaningful change in yield curve environment, which now factors in a rate cut in July and September, we expect our full year performance will track broadly in line with our January full year guidance, but there will be puts and takes with lower net interest income, offset by better fee income and expense performance with provision at the low end of the guidance range.

To sum up, on Page 17, our results this quarter demonstrate our continuing strong performance as we execute against our strategic initiatives, grow customers and revenues, carefully manage our expense base, deploy new technologies and improve how we run the bank.

And now let me turn it back to Bruce.

Okay.

Thank you, John.

Operator, why don't we open up for some Q&A?

(Operator Instructions) And first from the line of Matt O'Connor with Deutsche Bank.

So the way to stop [attrition], I think, it's a lot bigger than most have expected, and obviously, it covers a couple of years or a little bit of a longer period, but it's still much bigger I think than what it's been in the past and maybe what was expected.

Can you help frame how much of it actually falls to the bottom line, as opposed to like offset, say, core expense growth or inflationary growth?

I guess the question is, we see these numbers, we can make the adjustments on the onetime investments, the onetime costs, how much of that actually boosts the pretax earnings versus helps offset some of the other dynamic, such as rates, as you mentioned, and the core expense growth?

Yes, I think, Matt, what you've have seen historically from us is a commitment to driving positive operating leverage.

And so the TOP programs do a number of things for us, they give us that differential because they are oriented both towards finding efficiencies and helping expense line but also finding additional revenue sources and helping the top line.

So we would expect -- that's the principle commitment we have here.

We keep running the bank better, we keep serving customers better, and we have a commitment to continue to drive operating leverage, which will improve our ROTCE and efficiency ratio going forward.

It's a little hard.

We're not giving next year guidance on this call.

We don't give guidance till January.

So until we see how the rate trajectory moves between now and the end of the year, I think it's a little premature to make the call on that.

So would it be your hope that even in a kind of tougher, prolonged rate environment that the TOP initiatives are meaningful enough to get you that positive operating leverage even with the rate headwind as we think out medium term?

That would be the goal, for sure, yes.

Our next question is from Marty Mosby with Vining Sparks.

I was going to ask you, with the acceleration of the share repurchase, last year you front-loaded a lot of your share repurchase activities.

Are you thinking -- how is the timing of this year's plan, is it going to be even or a little bit more in 2019?

Well, I'll start, John, you can go, fine.

Last year, we did front-load a bit.

We want to still have firepower in every quarter.

But certainly, we think that the stock is at suppressed valuations, so it's a good time to buy some more stocks.

So you'll see us buying stocks in Q3 and Q4 at amounts that'll be more than you'll see in Q1 and Q2 of next year.

Yes.

I think that covers it.

Okay.

And then you have done a great job of getting these fee businesses kind of built-out.

How do you see -- what have been the reasons for your success when others have had a hard time being able to do this?

And then how do you see that kind of going forward?

What are still areas that you still think that you're going to be able to reap some of the benefits of what you've been investing in?

Sure.

We can -- it takes a village to answer this one.

So I'll go around the table, but let me start.

And I'd say on the commercial side, what we focused on is broadening our capabilities and then also expanding our coverage force.

And then working as a team to bring thoughtful solutions and value-add to clients.

And so that's really gained a lot of traction.

You can see it across the board, we have more products to offer to customers, more services to offer.

And I think we're doing a great job across the board in whether it's the Capital Markets, whether it's M&A, whether if it's FX and interest rate hedging, we're hitting record levels of fees every quarter.

We're winning jump balls against the megabanks, we have some really great capabilities.

And I'll let Don add to that.

Then on the consumer side, it's been a long effort to try to get our mortgage business and our wealth business, in particular, positioned for growth.

I think we're seeing that now.

We had -- certainly, Franklin had a great quarter and our underlying retail LO business had a great quarter.

So I think mortgage now is better positioned than certainly it has been.

There's still work to do in that business, but we feel good about the outlook.

And then also on the Wealth business, we've scaled it up.

We're penetrating our customer relations with, I think, a very good segment strategy in matching our product and offerings to the needs of the different segments that we're serving.

We did do a acquisition of Clarfeld to attack the very high-end or ultra-high-net worth client that is being integrated very effectively.

We have a lot of flow going in there.

So I think across the board, we feel good about the fee outlook.

We think it's sustainable.

And we're passing the baton, if you will, in a period where there will be some pressure on NII given rates, I think we can pick up the slack both with stronger free performance and continued good discipline on expense.

And then I think credit is in a really good shape as well.

So why don't we go around the table quickly?

John, anything to add?

No.

I think that covers it.

I mean there's a real emphasis around the organic investments coupled with the bolt-ons that we've done in wealth and mortgage have been quite powerful.

And all the organic investments that have been made in the commercial side are starting to pay off.

What I'd also add is that not only do we have a diversifying effect across the fee businesses within Commercial and Consumer, but even within Commercial, in the Cap Markets business, the things that we've done there to diversify across M&A advisory and loan syndications, where this quarter loan syndications were strong, last quarter M&A advisory and bonds were strong.

So you can see that even just with in lines of business as well as across lines of business.

So it's really pleasing to see that.

Yes.

Don, you want to go next for Commercial?

Yes.

Sure, I think it's been said.

But I think the thing that I would emphasize is we've been on this path for 4 years.

We've hired a lot of very talented people, we've added the 2 M&A acquisitions.

And the way we're integrating the soft clients' problems is really unique.

And I have been in this business a very long time, and I've never seen a team working together.

So you couple the capabilities with very long relationships that we've had, and we've got very high win rates.

You see this -- if you look at our week table results, you see us rising virtually every week table into a very, very strong position.

So I'll pick up on what John said, the thing that I like the most is the diversification but there is one market is a little bit weak, we can sort of find it in another market and continue the momentum on the fee.

So feel good about where we are.

Great.

And Brad, lastly but not least.

Okay.

I mean I think it's similar to Don's in some ways.

We've been building this capability for years now, I'm talking about it.

And when I look at the Wealth business, certainly the Clarfeld acquisition gives us new capability.

But we've been building out our value proposition for -- we've talked a long time about -- we're heavily weighted on [lenient] customers in our customer base.

And we've rebuilt that value proposition, we've been using data and analytics to do much more personalized and targeted offers, I think that's paid a dividend.

And then on the mortgage side, clearly Franklin American gives us unique capability.

But we've also been building digital capabilities.

And I think we're getting to the point where our digital capabilities are right there with some of the best-in-class in the industry.

Franklin American gave us much better diversification, the origination channel.

So I think just a lot of building the right pieces over time has gotten us to a good place.

Our next question is from Erika Najarian with Bank with America Merrill Lynch.

Could I just ask and help with some -- get help on the clarification with how we should think about net interest margin behavior under the scenario of July and September rate cut?

And also if we could get a little bit of color on how you're thinking about deposit strategy in terms of pricing as we face potential easing environment?

Yes.

Let me start, quick, John, and then -- so, Erika, I think we feel quite good about how we were kind of anticipating what was happening in the market.

We geared up with our TOP program to start looking at expenses.

But then also we got right on the deposit pricing, and we're very proactive in cutting deposit prices and optimizing across our different channels in the quarter.

So I think of all the folks we've reported, all the banks reported up to now, I think we have the lowest increase in interest rate deposit costs at 3 basis points of anyone who's reported.

So that feels quite good.

I think the 4 basis point contraction in NIM was also -- shows up very well versus peers, and I think it's really reflective of the emphasis we had on the deposit side.

I think going forward, we'll -- our guidance contemplates that there'll be 2 cuts and so we'll have to move through getting through this NIM contraction period, which we'll probably see some of the more that in Q3, but then I think we'll start to stable and level out after that.

John, you want to offer some more color?

Yes.

I think it's right.

I mean stabilization as you get towards the end of the year.

I think the dynamic that we're seeing is a couple of folds.

I mean you have to deal with -- when we started on this whole tightening cycle and we saw deposit betas start out low and begin to build over time, the end period betas getting the highest as you got into the end of last year.

And I think it's our view that you'll see the -- a similar profile in reverse, whereas you see the rate cuts come through, the benefit will start off a bit low as the deposit lag dissipates over time.

And then you'll see the deposit betas grow in sync and grow over time.

If in fact, the easing cycle extends beyond just an insurance cut or 2. So that's an important issue.

We also talked about pricing outside of just how your models work?

How do you ahead of pricing?

I think that we got ahead of some things throughout the last several months of late first quarter into second quarter.

In footprint, we were relatively early in sort of revising our commercial rates and revising our direct-mail campaigns.

And then you see more -- even more visibly, you see in the Citizens Access platform, where late first quarter, early second, we came -- we pulled back on marketing and reduced our CD yields earlier in the quarter and then reduced savings yields here in early July.

So I think all those actions that started late 1Q and into 2Q sort of showed up in what you heard from Bruce in terms of interest-bearing deposit costs being up only 3 basis points.

I think more broadly, maybe just to even take a further step back and think about what's going on with NIM overall outside of deposits, we also, as you heard in my remarks, embarked upon a program in the third quarter of 2018 to significantly increase our net receive-fixed swap position.

And we increased that by over 50% from around $9 billion to around $14 billion on a net basis, just dollar cost averaging over time.

And then we added to that position every quarter in the last 3 quarters.

And that plus some other actions we took to shift out our exposure to asset sensitivity to the long end of the curve.

So that now when the Fed does cut on the short end, we're actually more exposed to the long end of the curve than we are the short end of the curve for the first time in many, many years, which we think is a smart way to position as we head into these next 2 cuts.

Got it.

And a follow-up to that is there -- there is a thesis that for banks that have accelerated their deposit cost on the way up like Citizens.

There's a thesis that the net interest margin under the scenario of the forward curve, which includes 3 or 4 rate cuts between now and the end of 2020, that the net interest margin could bottom this year and potentially stabilize, if not increase, on a quarterly basis in 2020 as deposit cost repricing becomes more robust.

And I'm wondering is that too optimistic of a thought process for 2020, just based on the mechanics that you have walked us through?

Or is that possible for Citizens?

Yes.

I mean I think if you heard earlier, we're going to hold off on 2020 guidance here.

I mean I think that as you stay within 2019, you heard earlier from Bruce, which is right, that as you get into the end of the year, there's some stabilization that we expect to see in NIM as that deposit lag from the last hike in December dissipates.

And as the pricing lag really burns off, you'll see that dynamic happen.

And therefore, we do expect deposit beta -- the deposit beta for the second cut to be higher than the first, meaningfully higher, and we'll see how that all plays out and what the rate environment looks like and how -- we have to also build in what the competition for deposits are and how we're growing the balance sheet.

All of those dynamics play into the overall NIM outlook.

And as you heard from us earlier, we're looking to keep NII broadly stable into the third quarter as we're playing off loan growth against our net interest margin profile.

So I think that's how we...

I guess Erika, to your point I'll just add that while that might create some relative performance benefits, we're still asset sensitive.

So I think we're better off if we just see a couple of cuts here and then the Fed kind of creates the stimulus to keep the expansion going and then they stop.

That would be, I think, a preferable scenario from our standpoint.

Our next question is from Peter Winter with Wedbush Securities.

You guys mentioned the outlook for the third quarter, modest loan growth in the third quarter.

I'm just wondering, could you talk about the loan pipelines and overall customer sentiment right now?

I'll just off and I think others will jump in.

I mean I think that -- I think our pipelines are quite good.

When you look at where you see them in July, I'd basically call them strong and building.

And I'd say that even when you look out into the third quarter, on the Commercial side, I think we see nice growth in our expansion geographies and in our Industry Verticals.

On the Consumer side of things, we like the profile of education refi, mortgage and unsecured.

You have to keep in mind we do still have an auto runoff and there is the industry dynamics of home equity runoff that you've got to keep in mind.

So that's maybe more flattish.

But Commercial is -- looks good.

It's particularly in a spot basis as you get into the third quarter.

Yes.

I guess I would add to that, that I think we're still confident in our outlook that we'll hit the loan guidance for the year.

I think in the kind of second quarter and third quarter, we'll focus really on managing through the transition in rates and getting deposit cost right and getting NIM right.

So we've stepped up our BSO actions, and we're doing a bit more trimming of loan portfolios during this quarter.

We sold about $500 million of mortgages and on the last day of the first quarter, we sold about $200 million of corporate loans.

So those are going to affect our averages kind of in the middle part of the year.

But as John said, you see the pipeline's strong.

And so I think we'll see a pickup particularly later in Q4 that will leave us well positioned to hit the loan growth targets we've set out for the year.

Okay.

And then just within loans, could I ask about other retail?

I've noticed that the growth rate has slowed and loan yields have come down quite a bit.

Yes.

I mean I think there's a mix shift in that, in that there's a few components of that within other retail.

You've got a variety of things going on.

You've got the card business in there and that card business is tied to 3-month LIBOR and 3-month LIBOR's come down.

There's also some other things that -- in the unsecured space that, that would affect that in our Merchant Finance partnerships that would have an impact on that.

So yes, I think it's more mix than anything else, and I wouldn't say that that's really a trend...

The structure of how some of those partnerships work can be different based on the sharing agreements we have with those sponsors.

And so that can also cause different OpEx.

But there's no real pressures there.

There's no real -- maybe there's a little tightening of risk appetite, but nothing that dramatic.

Our next question is from Ken Usdin with Jefferies.

Just talking about how the letter math came through in terms of your capital return ask and then to your points about where the shares have been, can you talk to us about any changes in your view about that CET1 expected production and the pace of which, and might you think differently in the future about just balancing RWA growth versus getting back more to shareholders via the buyback?

Yes.

I'll go ahead and start off.

This is John.

I mean I think the pace of our glide path is still intact.

I mean I do -- we do have the -- we're on track and have an expectation of getting to our 10.2% number at this point.

And so it goes back to our -- broadly reaffirm our expectations for the year that we talked about earlier.

And I do think that -- so not a lot has changed on that front.

I mean we still find good value in terms of the buyback, as you heard from Bruce earlier, just in terms of how that works.

The -- and that gives us significant financial flexibility to support the investments we want to make in RWA growth as well as, from time to time, you've seen us do some bolt-on acquisitions.

And so that allows us to keep all of that.

That flexibility is nice to have as we get -- as we head into 2020.

And you've also seen us be able to increase our return in the form of dividends as we're getting that up into the 35% to 40% arena.

Eventually, as we get near a target, that'll moderate and it'll get back into dividend return and supporting RWA with a declining buyback eventually as you get closer to your target.

But for this year, our trends are intact.

And I would just reiterate, Ken, as I've said in the past, that our risk profile certainly is at median or better in terms of more conservative in my view.

So there's no reason longer term that we need to have a capital position that's above the median in the peer group.

Obviously, we'll take those decisions as we go in due course, but just worth pointing that out once again.

So I think we have flexibility to keep moving lower.

I think it's been, as John said, really great to have a little bit of cushion there that we can kind of have our cake and eat it, too.

We can have good loan growth.

We can do these bolt-on deals.

We can give very nice payback to shareholders and capital returns.

And so we still have a bit of room to run on that.

Got it.

And a follow-up it's just, how are you thinking about containing to remix in terms of the preferred stock which you're been doing over the last year?

Still have some more room to do, with rates where they are we think that it's pretty advantageous to get more of that done.

But just your thoughts on that would be great.

Yes.

I mean I think that we're below peers in terms of our -- that bucket, the [AT1] bucket, as you know.

And we've been filling that up a bit over time.

I mean we could see something like that in the future.

It's something we could early take a look at.

And I think it's served us well to do it over time.

I mean as we would've filled the entire bucket 6 months ago, we would -- we might have gotten all of that off at a level that would not be quite as favorable as something we might do over -- in the near future.

So yes, I mean, you may see something like that in the future, but we keep an eye on that.

And look, at that similar to our CET1 overall, we look at that as a glide path over time.

Yes.

And there, Ken, the [calibryst] is on where -- what's our return on equity and then what's the cost of the preferred stock.

And so there are opportunities now to get that arbitrage now that we've got the ROE higher.

We couldn't do it early days, during the turnaround phase, but now we have the capacity to do that and substitute preferred stock for further buyback.

So certainly something that's on the radar that we need to look at.

And the next question is from John Pancari with Evercore ISI.

On the -- just want to get a little bit more clarity on the net interest income guidance or the -- you reaffirmed your full year guidance.

So if you're now looking for 2 cuts, 2 Fed cuts by the end of the year, but you're reaffirming your 5% to 6.5% guidance, and you look for stable third quarter NII.

Does that imply that you could be at the low end of that 5% to 6.5% full year '19 NII guide?

Yes.

John, I think you might have misheard what we said.

So let me just clarify.

So we broadly reaffirmed the full year guidance overall.

So we feel that the guidance we gave back in January in terms of where net income and EPS would be, we still feel confident that we'll hit that, which is good.

And then we said that the kind of -- there'll be puts and takes to deliver that.

And so when we go through the major income statement categories, we'd be a bit to the left side of the goalpost but still positive on net interest income.

We would be to the right side of the goalpost and outperforming on fees.

We'd be to the left side of the goalpost on expenses and outperforming on expenses.

And we'd be near the bottom of the goalpost on credit.

So everything lines up very well.

The good news is that we found offsets to the unanticipated impacts from rates on NIM.

So we called out now that our loan volumes will likely be where they thought they'd be.

The one kind of missing link in the equation is that NIM is going to be lower than our going in assumption when we started the year, and -- but we'll make up for that in other ways.

Got it.

All right.

That's helpful, Bruce.

And then separately, on the efficiency outlook.

I know you had previously indicated a medium-term efficiency target of about 54%.

How are you feeling about that now given the backdrop?

I still think we're going to get there.

So one of the advantages of this TOP 6 program it's going to continue to help drive the efficiency ratio improvement that we need to get our returns up, without a tailwind from rates or even just stable rates which we've actually moved to a declining in rates.

It might take a little longer to get there, but we're still committed to hitting those targets.

Our next question is from Gerard Cassidy with RBC.

John, you mentioned that you have less exposure now from the repositioning of the balance sheet to the short end of the curve and there's more asset sensitivity tied to the longer end of the curve.

Can you share with us if the long end of the curve goes up to 2.75% by the spring of next year or at the end of this year, what kind of benefit would you see from that?

And vice versa, if when they cut rates, if the whole shift in the yield curve comes down, what would that do to your outlook?

Yes.

So I'll just maybe take it at the overall level, and you can break it down short and long.

I mean overall, in the instance of, call it, a 25 basis point across the curve decline, shift down, parallel shift down, you would see something in the neighborhood, a model, call it, $60-ish million impact on a full year.

Quarterly, that's about $15 million.

These are all modeled outcomes and you'd have to -- a lot of outside-of-model things that would have an impact on that.

But that's about what you would see, is about $15 million a quarter which is in the neighborhood of 4 basis points.

But that said, we almost never see those yields -- those parallel yields, it shifts down.

If the shift down is on the short end, we have a much lower exposure, which is what we're expecting, right?

We're expecting short-end cuts of it, of 1 or 2 this year.

I mean we've modeled 2. But in that case, within that and given quarter, it's now just a couple of single-digit millions of net interest income exposure, which is what the impact of shifting exposure of the court has really done.

So now we're right around 25% of that $15 million, is sensitized to the short end of the curve falling.

So -- and it's not exactly symmetrical, but directionally symmetrical on the up.

Not that anyone's expecting that anytime soon, but that's how it works out.

And then just to confirm, when you were saying the 25 basis point parallel shift, and I agree with you, we really don't see that.

When you mentioned $15 million a quarter, that's down, correct?

That's down, yes.

So...

Yes.

Okay, okay.

Yes.

I think that -- and as a result, I mean, really, what we've positioned ourselves to do here is that in a yield curve shape that there's a more upward sloping, that's where we've positioned ourselves to benefit more today than we would have, call it, a year ago.

A year ago, all of our benefit is really -- for most of our benefits, was focused on rates rising on the short end.

About 70% or 75% of our sensitivity on the up was tied to the Fed raising rates.

And so as we mentioned earlier, in the third quarter of last year, we started to bring the overall level down.

And in the early part of this year, we shifted all of the -- most of the sensitivity out to the long end so that -- because of just kind of positioning for the end of the rising cycle and, frankly, feeling like over time, call it, over the next year or so or even into 2 years, we would expect the yield curve to steepen, and we think that's a appropriate way to position the balance sheet today versus where we were a year ago.

And just -- Gerard I just wanted to make sure you've heard that, it's not $15 million in a quarter, there is a -- the next move down because of this positioning with the hedges, it was $4 million...

Correct.

Rather than $15 million.

So we've got out of ahead of it and we've -- I think bought some insurance for the moves down.

Exactly.

And that's fallen by 1/3.

A year ago, that would have been, call it, $12 million on a one move down and now it's $4 million.

So we've cut by 1/3 our exposure to the Fed lowering rates, which has turned out to be a good way to sail into the second half of 2019.

Very helpful.

And maybe Don can answer this one.

You guys touched on the new cash management, treasury management products on the Commercial side, and I think you called it accessOPTIMA.

Can you share with us -- and you're gravitating existing customers into that product.

Can you share with us how challenging is it for a -- to get a new customer into this type of product, treasury management, when they are already with a bank and have all their lines tied to that existing bank.

So when you win a new customer, is it easy or is it difficult to get them in on the treasury management side?

It's difficult but it will getting easier.

So the more sophisticated a customer, the tougher it is to transition a big cash management portfolio.

But as we're expanding our middle market and doing more smaller-sized deals, it generally comes with the banking relationship.

So if we're adding a new client, there's a good chance that we're going to get the -- keep the cash business along with that.

The tough thing has been our - for our portal, which was called the accessMONEY Manager, it was very substandard.

So we didn't have an incredible market offering, which with accessOPTIMA, we're as good as anybody else.

And the early feedback from clients that we're migrating, we've migrated about 1,200 already, is very, very strong on the platform.

It's a platform which has got an underlying technology for a company called Bottomline on it.

So we will upgrade the platform constantly as they upgrade their technology.

So we'll stay in sync with the rest of the industry.

So it works on a number of different levels.

And one of the things that shouldn't be lost on people is the core cash business is just part of the cash management offering.

So if you look at our card business, which has been sailing over the last few years, it's growing at 20%, 25% a year, to your question, Gerard, that's an easier sale because for a lot of companies, they don't have a card program already.

So it's not a technology transfer, it's an additional, newer way to integrate the payables businesses.

And we've been doing quite well on that side.

And that's been driving our kind of 2% to 3% growth in the overall cash management business.

So we think that increases and we think Optima helps.

But it is difficult to transition a big cash management client.

Got it.

And the 1,200 customers that you've already migrated, what percentage of that -- of your commercial book is that about?

That includes business banking, so it's probably about 15% of the overall client base.

Yes.

We're going to do it 4 waves between now and Thanksgiving to get everybody on to the new platform, that's the plan.

It's a test and learn as we translate.

So we'll fix little bugs as we go along.

So it's been very little so far, but we certainly don't want to do a massive migration and have something that comes out of the woodwork.

So this has been very well tested.

We've been piloting it actually for 6 months already with some core clients [sitting in] our advisory board.

So we're very confident in the quality we offer.

Our next question is from Ken Zerbe with Morgan Stanley.

With the transformational part of the TOP program, how is what you guys are doing with new cloud, AI, digital, different from what you've already been doing on the tech side previously?

And also different from what other banks are also doing on the tech front?

Yes.

I think there's really 2 elements to kind of the tech ecosystem in TOP 6. One is really around infrastructure and having the kind of [dev stack ops] infrastructure, migrate to something that's cloud-based.

We've had some progress on that to date, but we're really going to accelerate that over the next couple of years.

The second big element is how we design and develop applications.

And that really is migrating to an agile approach with a bunch of teams that work across the business, those staff functions and technology to get to market faster with more nimble and flexible approach.

We probably have 50 pods, as they're referred to in the trade, up in our agile environment today.

We're going to quadruple that over the next couple of years.

So it's quite a significant change in terms of how we support and roll out new technologies.

Okay.

Helpful.

And then in terms of the balance sheet optimization program, at this point, I know it's been going on for several years now, given where we are in the rate cycle, is the balance sheet optimization still having a meaningful or even a noticeable impact on kind of remixing and higher-yielding assets?

Or at this point, is it more just a factor of your existing loan portfolio and the outlook for rates?

Yes.

It's still -- this is John, it's still a pretty -- a very good part of what we're doing here.

And there's a lot of room left to run in that program.

Whether you look at the asset side of the balance sheet or deposits, we are not where we would expect to be in the next couple of years.

We have a target balance sheet expectation, where the balance sheet optimization will continue to contribute over the medium term.

You'll see on the asset side of things, across asset classes, we're still repositioning auto, as an example, in asset finance.

Within asset classes, we continue to rotate and recycle capital and get better and better at where we allocate that scarce resource of liquidity and capital, so there's a lot left to go down on the asset side.

On the deposit side of things, there's also a lot of exciting things happening there.

When you look at DDA as a percentage of total deposits, we're still below peers.

And I think that, that percentage doesn't fully reflect all the organic investments that have been getting made in Brad and Don's areas that have started to show up actually.

And you look at the last year, I think, we've outperformed DDA across the board in terms of percentage growth.

And so there's a lot more left to go there that we think is a big part of what we're doing as well as diversifying, call it, in the Commercial space in terms of our deposit sources.

So that program is alive and well, lots left to go.

And in the current quarter, whether you look at it quarter-over-quarter or year-over-year, there's a positive contribution from BSO that's allowing us to -- that's a tailwind, that is one of the things that we count on to help us in our NIM performance as we sail into the headwinds of the rate environment.

And is it possible to quantify some of the impacts?

I'm meaning if you just assumed a static balance sheet but then you apply sort of the remix of where you are versus where you want to be, like and quantify the impact?

Yes.

And there are -- I mean, yes, I think quarter-over-quarter, our estimates are -- we're in kind of the mid-single digits of positive benefit in the second quarter of '19 compared to second quarter of '18.

It's best to look at it year-over-year.

Because there's a fair bit of volatility quarter-to-quarter.

And that's right in line with what we try to do for any given year.

It's right around that, call it, 4, 5 basis points, and we could get that.

And I'm really -- it's part of the story, it's not the entire story but it's part of the story when we look at our NIM performance this quarter being down 4 basis points compared with peers.

And you've got to give some of the credit to our BSO programs which are -- which we spend similar amount of time on compared with TOP.

I mean we do that on a very disciplined basis month-to-month, working with our entire businesses, and it's continuing to pay dividends.

And next, we go to Saul Martinez with UBS.

Couple of questions on my end.

First on -- I just want to make sure I understand the NII guide for 3Q.

Because you've highlighted -- I mean the $20 million, $15 million a quarter on a 25 basis point cut with only 25% being at the short end, so it's $4 million.

And just assuming a July cut, you're only getting 2 months of that.

So the impact seemingly of a July cut is pretty negligible on NII.

If that's the case, why are we assuming NII stable and not growing?

Is it the long end of the curve on average is going to be lower?

It just -- it seems like this rate cut is really not going to impact 3Q, I would think you would actually see NII growth, if that were the case.

Yes.

There's a couple of things that are going on.

You've got a -- certainly, the impact of LIBOR is built into all of this.

But you've got a 20 -- you've got an expectation of LIBOR being down around 25 basis points or so.

But I mean you've got these models' results, there's 2 things to keep in mind.

And you've got the deposit lag that continues to have an impact, and as I mentioned earlier, the first cut that occurs in a easing cycle will have a lower deposit beta than, let's say, the next cut.

And the numbers I was quoting to you earlier are averages over a year.

So in the first quarter of any kind of -- of any reversal of direction on rates, you'll have a lower benefit on deposit betas coming down than you'll have eventually after the full effects of that cut burn in, in future quarters.

So that's the -- really the main issue is really how that deposit lag flows in.

I'd say that you also have to keep in mind our front book, back book, which has been a tailwind for us and remains a tailwind, but the magnitude and strength of that tailwind has come down a fair bit based upon where long rates are.

And so when you look at long rates being down 25, 30 basis points in the quarter and continuing to -- the full impact of that has to be offset as well.

So I think 3 quarter could be seen as maybe a transitional quarter as we get through.

What's going on with that first cut, which immediately impacts us on the asset side.

There's 100% beta on all our floating assets, that happens right out of the gate.

But the deposit beta, our deposit betas are less than that and deposit lag, in front book, back book.

And all of that tends to really stabilize itself as you get into the fourth quarter.

That's helpful.

And on that latter point on the asset beta, how do we -- obviously, you've increased your fixed rate received positions over the last year and you've had balance sheet optimization.

How do we think about loan yield betas, commercial loan yield betas, retail loan yield betas, with a 25 basis point cut?

Because even this quarter, I think you actually see a basis point of yield expansion on Commercial even with LIBOR coming in.

How much of that actually goes through, given all the mixing, the hedging, how much of it actually goes -- will go through into your loan yields?

Yes.

Maybe just top of the house, it'd be good to talk about the fact that we are generally 50-50 in the loan portfolio.

After you consider swaps, we're generally 50% floating, 50% fixed.

And that was true in the first quarter.

But after continuing our program of adding receive-fixed swaps, we're a little lower on that front.

So you could basically say that our loan portfolio was down from 50% floating post-swap to 45% or so post-swap.

So therefore, our -- back to the point that we're indicating, our overall asset sensitivity is falling, in part, due to the fact that our loan betas will likely be a little lower at the margin due to the hedging that we've done.

And also due to, even more importantly, all the hedging impacts by shifting all of it out the curve.

So we've been positioning and all of that will flow through in loans and deposits.

We've been positioning for exactly this kind of environment, where the long end up is a more likely expectation of a tailwind than -- over time, over the next several years than counting on the short end to be up meaningfully, and I think we're really pleased with how we've positioned that.

So that -- hopefully, that helps.

Yes.

I'm sorry, just one, you said 45% loan or interest-earning asset is floating?

45% of the entire loan portfolio is -- can be considered floating post the impact of swaps versus 50% last quarter.

And it was a little higher the quarter before because we've been adding...

A year ago.

Because we've been adding the receive-fixed swaps over the last 3 quarters.

And our next question is from Lana Chan with BMO Capital Markets.

Just wanted to follow-up on that last point on the swaps.

Could you give us any details around the $14 billion of swaps, the terms, the rates?

And if any of them are forward starting?

Yes.

And none of them are forward starting.

I mean the terms are basically -- our receive-fixed swap position is, on a gross basis, is around $20 billion.

The reason I kept saying net is because that's offset by about $5 billion or $6 billion of pay-fixed swaps that we executed, that are important to know.

That's how we shifted our sensitivity out the curve as we executed some pay-fixed swaps at around 1.70% or so at the 5-year mark, which cost -- which basically indicated that our sensitivity is now out of curve.

The gross of $20 billion on receives are basically in the neighborhood of 2 years of remaining maturity.

And that's basically protecting against a potential easing cycle over the next, call it, 2 years, which is where those receive-fixed swaps protect.

And then we're leasing that sensitivity as you get out further in over the medium term, where we think that it's more than likely that, that will cover any easing cycles that might flow through.

Okay.

And sorry, the average receive rate is what on those swaps?

It's probably closer to 2%, it's in the, like, call it, 1.85% to 2% range.

And we've been [talking about] averaging in over the last 3 quarters, so it's around that average.

Yes.

It's all the questions?

Yes.

I'll turn over to you, Mr. Van Saun, for closing remarks.

Okay.

Well, thanks again, everyone, for dialing in today.

We appreciate your interest and your support.

Have a great day.

Ladies and gentlemen, that concludes today's conference call.

Thank you for your participation.

You may now disconnect.