Citizens Financial Group Inc (CFG) — Q2 2018 Earnings Call Transcript

Thank you so much, Paul, and good morning everyone. We really appreciate you joining us on another busy day. Our Chairman and CEO, Bruce Van Saun, and CFO, John Woods, will start the call by reviewing our second quarter results, and then we're going to open things out for questions. Also with us in the room today are Brad Conner, Head of Consumer Banking, and Don McCree, Head of Commercial Banking. So, I need to remind you that in addition to today's press release, we've also provided a presentation and financial supplement that you can find on our website at investor.citizensbank.com. And of course, our comments today will include forward-looking statements, which are subject to risks and uncertainties, and we provide information about the factors that may cause our results to differ materially from expectations in our SEC filings, including the Form 8-K we filed today. We also utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our SEC filings and earnings release. And with that, I'm going to hand it over to Bruce.

Okay. Thanks, Ellen. Good morning everyone, and thanks for joining our call today. We're pleased to report another very strong quarter paced by strong top line growth of 8% and good expense management, which combined for positive operating leverage of 4.3% year-on-year. We achieved good balance sheet growth with 2% sequential average loan and deposit growth led by strong performance in commercial. Year-on-year, our loan growth was 3%, and deposit growth was 4%. We continue to feel good about our capital management strategy; that is, we have been able to fund strong organic loan growth, deliver attractive levels of capital return to shareholders, and target modest size fee-based acquisitions to expand our product and service offerings. Today we announced the 23% increase in our dividend to $0.27 per common share. We also remain on track to close our Franklin American Mortgage acquisition in early August. The strong executive performance so far in 2018 continues to deliver impressive improvement in key metrics. In the second quarter, our EPS grew by 40% year-on-year, our ROTCE improved to 12.9%, which is up 3.4% year-on-year, and our efficiency ratio improved to 58%. We remain confident in our outlook for the second-half with strong performance expected to continue. Today we announced our TOP V programs, which is not a surprise since we have one every year, but certainly not something that should be overlooked. Our management team operates with a mindset of continuous improvement. We are constantly seeking ways to run the bank better and to do more for our customers. The program announced today builds on the work of previous programs delivering approximately $100 million in run rate benefit by the end of 2019, with two-thirds of that coming from the expense side. These programs have been key to both our consistent delivery of positive operating leverage and our rising customer satisfaction scores. We continue to achieve good external recognition for our progress with customers and on innovation. Suffice to say, we feel we've shifted from playing defense and catch-up to now playing offense and leaning forward to utilize new technologies, embrace the digital operating model, and leverage data. More work to do, but we are heading in the right direction. 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.

Thanks, Bruce, and good morning everyone. I'll run through the highlights of our second quarter results which start on Slide 3. We generated net income of $425 million and diluted EPS of $0.88 per share, which was up 13% linked quarter and up 40% year-over-year. Once again, we delivered solid positive operating leverage of 7% year-over-year, or 4% on an underlying basis adjusting for some notable items we had in the prior year. Net interest income of $1.1 billion was up 3% linked quarter, driven by 2% average loan growth. Our net interest margin increased two basis points linked quarter and 21 basis points year-over-year. I will cover the margin in more detail in a few minutes. We delivered nice growth in fees, which came in at $388 million, up 5% linked quarter and year-over-year, and up 2% on an underlying basis from the second quarter of 2017, which included near record capital market fees. We continue to make progress on our efficiency ratio, which came in at 58%, roughly a 2.5 percentage improvement linked quarter and year-over-year on an underlying basis. This strong performance drove a nice improvement in ROTCE, which came in at 12.9% compared with 11.7% in the first quarter and 9.6% in the second quarter of last year. These excellent results reflect our commitment to delivering strong revenue growth while maintaining operating expense discipline, resulting in consistent and robust operating leverage. As you know, we are always looking to find ways to run the bank better and improve our return. In a few minutes, I will walk you through the next phase of our TOP program, which will contribute further efficiencies and revenue opportunities for us, while funding investments to drive future growth. Let's go to Slide 5 to cover our NII NIM results. Despite a very competitive environment, we continue to deliver attractive balance sheet growth with average loans up 2% linked quarter and 3% year-over-year, which helped us drive a 3% linked quarter increase in NII. Our net interest margin improved in line with our expectations, up two basis points linked quarter and 21 basis points year-over-year, reflecting a nice improvement in loan yields, given the pick-up in short-term rates and improvements driven by our balance sheet optimization efforts, where we were able to shift the mix of our loan portfolio towards high return categories. Loan yields were up 19 basis points this quarter, more than offsetting higher funding costs of 15 basis points, which reflects the full-quarter effect of $750 million in senior debt we issued in late March and the impact of the rise in short rates on our deposit cost. Note that we grew period-end deposits by over 1% in the second quarter and the spot LDR ended the quarter at 97.5%. Taking a look at fees on Slide 6, non-interest income was up 5% linked quarter and 2% year-over-year on an underlying basis. The improvement in linked quarter fees was driven by a strong quarter in capital markets, where we continue to leverage investments we made in talent and broadening our capability. Market conditions in the second quarter helped drive robust activity in loan syndication, where we closed a record number of transactions and nearly doubled loan syndication fees from the first quarter level. FX and interest rate product revenue was a record for us this quarter, up over 20% on a linked quarter basis and over 30% year-over-year, reflecting the increase in loan demand and a favorable interest rate and currency environment, which drove increased hedging activity. Linked quarter service charges and fees were up from a seasonally lower first-quarter level, while trust and investment fees increased, reflecting higher sale volume. The remaining fee categories were relatively stable linked quarter. On a year-over-year basis, non-interest income also benefited from strong contributions from FX and interest rate products and from higher trust and investment fees. Capital market fees were down modestly compared with the record levels in Q2 '17. The outlook for Q3 is strong as our pipeline and activity levels continue to be robust. Turning to Slide 7, our expenses remain well-controlled. Linked quarter expenses were down $8 million, given the seasonal decrease in salaries and benefits. Outside services were $7 million higher, reflecting costs tied to our strategic growth initiatives and work we're doing to run the bank more efficiently. Other expenses were also $7 million higher driven by an increase in advertising and charitable contributions. Our expenses also included about $3 million of transaction costs related to the Franklin American Mortgage acquisition, which we expect to close in early August. Year-over-year expenses were up 3% on an underlying basis, including higher salaries and benefits and outside services expense, driven by continued investment to drive growth. We remain focused on finding ways to self-fund our growth initiatives and are doing a good job of finding efficiencies with same discipline. Let's move on and discuss the balance sheet in Slide 8. You can see we continue to grow our balance sheet and expand our NIM. Overall, we grew average core loans 2% linked quarter and 4% year-over-year, driven by strength across most of our commercial business lines and in education, mortgage, and unsecured retail on the consumer side. The growth in commercial loans was somewhat impacted by the sale of $353 million of lower return commercial loans and leases near the end of the quarter, associated with our balance sheet optimization initiatives. For the quarter, our period-end loan growth was 1.8% or 2.1%, excluding the impact of this sale. Our loan yields continue to improve, given our balance sheet optimization along with continued discipline on pricing. We also benefited from higher LIBOR rates during the quarter. We remain well-positioned to benefit from the rising rate environment with asset sensitivity to a gradual rising rate to 4.6% versus 5% last quarter. Our asset sensitivity has naturally moderated given the rising rate environment. Let's take a look at our funding costs on Slide 9. Total funding costs were up 15 basis points, which reflected 11 basis points tied to deposit costs and four basis points associated with borrowed funds. This included the impact of the $750 million senior debt issuance late in the first quarter. Year-over-year, our total cost of funds was up 33 basis points, reflecting a continued shift to greater long-term funding along with the impact of higher rates. This compares with asset yield expansion of 51 basis points. The industry overall has seen some increased deposit competition, but for the most part, deposit costs have been relatively well-behaved, and I'm very pleased that we continue to grow DDA. Our cumulative data on interest-bearing deposits is now at 28%, and remains in line with our overall expectations, given where we are in the rate cycle. We continue to invest in analytics to improve our targeting for digital and direct mail offerings from the consumer side. And in commercial, we are making investments to build out additional product capabilities and to roll out our new cash management platform early next year. Also, earlier this month, we launched Citizens Access, which will contribute to our funding diversification and optimization of deposit levels and costs. We expect to raise about $2 billion of deposits through this nationwide direct to consumer digital channel by the end of the year. So this is a relatively small part of our overall deposit strategy. We think it will be an excellent complement to our highly-accretive retail lending initiatives, such as education, finance, merchant finance, and home equity. We are very excited about this platform giving us access to a whole new set of deposit customers with minimal effect on our existing deposit base. Next, let's move to Slide 10 and cover credit. Overall credit quality continues to be strong, reflecting the continued mix shift with higher quality, lower risk retail loans, paired with the stable risk profile in our commercial book. The non-performing loan ratio improved to 75 basis points of loans this quarter, down from 94 basis points a year ago. The net charge-off rate of 27 basis points for the second quarter is relatively stable both linked quarter and compared with the prior year. Retail net charge-offs improved from the first quarter, mostly reflecting a seasonal improvement in auto. Commercial net charge-offs for the second quarter were up $15 million versus last quarter, which benefited from a modest net recovery. Provision for credit losses of $85 million included a $9 million reserve build, primarily tied to loan growth. As we increase the mix of higher quality retail portfolios in our overall loan book, our allowance for total loans and leases ratio has decreased modestly to 1.1%. The NPL coverage ratio improved to 148% from 144% in the first quarter and 119% in the second quarter of 2017, given continued reductions in NPLs and run-off in the non-core portfolio. On Slide 11, let's cover capital. We ended the quarter with a strong CET1 ratio of 11.2%, which was stable compared to the first quarter and the prior year. This quarter as part of our 2017 CCAR plan, we repurchased 3.6 million shares and returned $257 million to shareholders, including dividends. It's also worth noting the total amount returned to shareholders in the 2017 CCAR window was $1.3 billion, including dividends. As you know, we received a non-objection to our 2018 CCAR capital plan, which includes up to $1.02 billion in share repurchases. We announced an increase in our dividend today by 23% to $0.27 per share, and we also have the ability to increase the quarterly dividend again to $0.32 per share in the first quarter of 2019. Overall return of capital to shareholders in the plan is up $300 million, or 23% versus 2017 CCAR. Our planned glide path to reduce our CET1 ratio by at least 40 basis points over the cycle remains on track, and we remain confident in our ability to continue to drive improving financial performance and attractive returns to shareholders. Let's move on to Slide 12. Our TOP programs have successfully delivered efficiency that allows us to self-fund investment and continue to drive future growth. We have executed very well on the TOP IV initiative, which is now expected to deliver $100 million to $110 million pre-tax by the end of 2018. We are also very excited to share the details of our new TOP V program today, which highlights our focus on continuous improvement and delivering value to our shareholders. This program targets a pre-tax benefit of $90 million to $100 million by the end of 2018 with approximately two-thirds tied to efficiency initiatives. On the efficiency side, we are constantly challenging ourselves to do even better, and we continue to see further opportunity. We will continue to focus on transforming our branch footprint in support of our shift to an advisory service model. We are also working to simplify more of our organization by leveraging new process improvements and agile ways of working across the bank. Our customer journey work will drive end-to-end process efficiencies with simple and excellent customer experiences. On the revenue side, we are embarking on the next phase of our data analytics efforts to enhance the targeting of our product offerings and improve the customer experience. We will continue building out our fee income capabilities to new work on customer journey and the build out of full-service bond underwriting capabilities. And we are planning to continue our successful commercial banking expansion into attractive MSAs, such as Dallas and Houston, where we already have a presence tied to industry verticals. In short, our management team remains fully committed to strong execution of these programs, which allows us to serve our customers better, make the company stronger, and deliver long-term value to our shareholders. On Page 13, we have provided color on how we are progressing against our strategic initiatives. This slide highlights some of the progress we are making against our efforts to optimize the balance sheet and the investments in our fee-generating capability. We also wanted to highlight some of the interesting things that are going on in our businesses as we remain focused on becoming a top-performing bank. On Slide 14, you can see the steady and impressive progress we are making against our financial targets. Since Q3 '13, our ROTCE has increased from 4.3% to 12.9% as we approached the lower end of the range of our 13% to 15% medium-term ROTCE targets this quarter. Our efficiency ratio has improved by 10 percentage points over that same timeframe from 68% to 58%, and EPS continues on a very strong trajectory as well, up to $0.88 from $0.26. Let's turn to our third quarter outlook on Slide 15. I should point out that this outlook is before the impact of Franklin American Mortgage, which we expect to close in early August. On the bottom of the slide, I will talk a little about the impact we are expecting for the third quarter from the transaction. On a standalone basis, we expect to produce linked quarter average loan growth of around 1.25%. We also expect the net interest margin to continue to expand modestly in linked quarter. In non-interest income, we are expecting to see a modest increase with continued strength in capital markets, given the strength of our pipeline heading into the third quarter. We expect non-interest expense to be up modestly in the third quarter with positive operating leverage and further efficiency ratio improvement. Additionally, we expect the provision expense to be in a likely range of $85 million to $95 million. And finally, we expect to manage our CET1 ratio to end the third quarter around 10.9%, including the impact of Franklin American Mortgage, and expect the average LDR to be around 99%. Moving to Slide 16, we expect the Franklin American Mortgage transaction to close in early August. It should contribute about $550 million of loans held for sale and about $600 million at the end of the quarter. We expect expenses to be in the same range as fees excluding integration cost of about $10 million in the quarter. As we told you when we announced the deal, we expect our CET1 ratio to be impacted by about 18 basis points. To sum up on Slide 17, our strong results this quarter demonstrate our ability to 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. Our outlook remains positive as we work to become a top-performing regional bank. Let me turn it back to Bruce.

Okay. Thanks, John. Paul, why don't we open it up for some questions?

Thank you. Good morning, guys.

Hi.

First, just sort of a tic-tac question on the guidance, the 1.25% average loan growth expectation for the third quarter. It's granted a very subtle change, but just a little lower than the 2Q. John, I guess I am wondering if there has been any change in demand, customer appetite, et cetera, or is that just a function of the late 2Q portfolio sale? In other words, are we sort of at a steady state 6% annualized on kind of apples to apples basis, or has there been any change in your mind?

I'll start off, Scott, and then John and maybe Don can offer commentary. But I would say we feel very good about our ability to originate loans, particularly on the commercial side. And we had a very strong pipeline coming into Q2. We were a little sluggish in Q1 as the whole industry was, but ultimately we're going to trend in line with the industry. Because of the hiring that we're doing, and the geographic expansion and build-up of some of our verticals, I think we should be kind of at the north end of where our peers are, which we have been able to sustain. I think the outlook for Q3 continues to be very positive on the commercial side. We've got good pipelines heading into Q3, and the sale that we did late in the quarter is just part of our balance sheet optimization efforts. And that probably impacts the outlook by 25 to 30 basis points. So you would probably be looking at an annualized rate of 6% or so in the third quarter, absent the impact of that sale. Consumer has been somewhat impacted by market conditions being a little sluggish in the first half. There is usually a seasonal pick-up in Q3 tied to our education finance business. And so, we would expect to see a bit of a pick-up there. As you know, we are running down auto and we have had HELOC as a phenomenon in the market that's been prepaying and paying off. And so, we have had that as a little bit of a headwind on the consumer side. But overall, I feel very good about the outlook for growth, and I think if we are kind of on a year-to-date basis a little bit behind on loan growth, we have made up for it with running ahead on NIM, where we have had another rate hike than we assumed going into the year. And so, I think the NII outlook continues to track really well for the full-year, maybe a little less on loan growth, little more on NIM, but certainly moving towards the high-end of the goalpost for the full-year outlook. I have said a lot, John; you want to pick up the ball from there?

Yes. It's a real high-level point maybe on consumer and commercial. So, some headwinds as you mentioned with auto running down and a pick-up and some attrition that we have seen in home equity, but things looked to be balanced out a little bit in 2Q. We are looking forward with refi, some strength in mortgage, and in the unsecured space overall. So that looks good. And in commercial, as you mentioned, lending pipelines are holding strong. After a very solid 2Q, we still see the pipelines holding steady in both the C&I and CRE space. So from that perspective we are feeling good about it. And if you look at how we are comparing, Bruce gave you the overview, but when you think about how we are looking versus peers, pretty much across the board, we are either in line or better. So I think we are executing well on that front.

Okay.

Don, you have any comment?

No, just confirming the pipeline looks good. I feel very good about the fact that - you will see it continue to manage the balance sheet for assets that are just not working for us on a total return on yield basis. And the good news about the assets we sold is we sold them at far better pricing, which is a reflection of where the market is. So, it was a very attractive sale for us.

Okay.

Yes. And I would just add one last point, Scott, is that we're constantly calibrating – we have loan growth opportunities. Do we pursue all of that, or do we either look at the back book or throttle back on the front book depending on where we think the funding costs are going to go, where we need deposits to fund the loan growth? And so that constant calibration is what it's going to cost us to fund the loan growth, is it going to be NIM accretive, is it going to be ROTCE accretive? And I think what you are seeing is that we have been able to sustain loan growth at the high end of peers, still have our NIM expand, still have our ROTCE expand because of some of the attractive lending pockets that we've identified.

Okay, that's perfect color. Thank you. And then if I can ask just one really quick separate one on the mortgage company acquisition? Granted it's small, but on the financial information you detailed on Slide 16 for the impact, does the accretion grow at all after the third quarter? Or once we pop in the NII fee and expense impact for the third quarter, is that sort of steady state from there on out?

Yes, thanks, Scott, good question. So yes, what that reflects exclude the synergies that once we close on the deal, we will start executing against the various expense synergies that we talked about on the funding side, on the operational side, and in the servicing category. So you can – I think we mentioned that we would expect that things would be modestly accretive in the second half. And so that's our outlook there. And we talked about the 2% in 2019 and 3% in 2020, but – so that's what you're seeing on the synergies.

Okay, terrific. All right, thank you guys very much.

Thanks.

Good morning.

Hi.

Back to the commercial loan growth just want to see if you can give us just a little more color on what is really driving that in terms of loan types, is it more larger corporate? And then if also you can give us an idea where the new money yields are for the commercial loans that are coming on the books right now? Thanks.

So it's really across the board. I mean, it's concentrated in some of our industry verticals which tend to be slightly larger accounts and our expansion mortgage which also tend to be slightly larger credit, so more of mid-corp and middle market. And the reason for that particular expansion mortgage is we're being careful on credit quality. So as we are in new markets, we want to be dealing with bigger companies with slightly more financial flexibility. We are also seeing a little bit better utilization of working capital, which I think is indicative of some of the tax effects coming through with particular our midsized companies. And we are seeing a decent amount of M&A activity in terms of funding of M&A-oriented activities in the client base. And I would say yields have held up pretty well. I mean, our front book originations aren't too far off our existing portfolio. And we are being selective. If we are seeing overly competitive situations where yields are unattractive from a return basis, and we don't have cross-sell, we are passing. And we have actually seen a fair amount of aggressiveness in the market which we don't like. But we are being highly selective in terms of where we thought. And the way we look at it is not just loan yields, but it's overall return on credit extension, so it includes cross-sell capability into our cash management business as well as our capital markets and mortgage business.

And just to add a little bit to that, the new loan yields coming in our middle market space are in the mid 450s or so. And you can see that we are as yields continue to go up, driven by the Fed, we're able to capture most of that into the coupon from the front book, and that plus cost will drive very attractive funding opportunities as we look at that base.

Got it, okay, thanks. Separately, regarding the loan loss reserve, I understand it's come down to about 110 basis points overall. How are you assessing that level, especially considering the growth you've experienced in certain loan portfolios, such as commercial loans, and the current phase of the credit cycle? What are your expectations for that going forward?

I'll start and then maybe John can add his thoughts. However, that has seen a slight decline, I believe. If you look back a couple of years, it was around 116 to 117 and now it's about 110. Several factors contribute to this. Clearly, the credit back book is very clean, which is one aspect. Additionally, as we remix loans and phase out older, riskier loans, we are expanding in areas where our consumer credit risk appetite is strong. This remixing also allows for lower overall reserve levels. Therefore, I believe it's a reflection of our current credit risk appetite and the state of the credit cycle, and we feel positive about these levels at this moment.

Yes, just would add, I think we would see now that there are in terms of where we are in the cycle, when you look at charge-off rates being where they are in the 20s, we all imagine that's on the lower end of where things will likely be through the cycle. But just how the accounting works and that's what we are tied to, how the accounting works we are looking at the current loss model, which really wouldn't allow us to really put out much more than what we are doing. And I mean I think the…

We are building reserves. Two quarters in a row, this quarter we had a $9 million bill provision over charge-offs. So I think we're keeping up with some of that loan growth, but we have such good results on that credit backlog that's netting to not much of an increase in the overall allowance.

Yes, the shift in mix that Bruce mentioned is a factor. We are seeing improved quality in the new loans, which is benefiting our overall positions.

Okay, got it. Thank you.

Hi, good morning everyone. I have a couple of questions. First, could you share your outlook on deposit costs being up 11 basis points? When I look at interest-bearing accounts, they have increased by about 15 basis points sequentially. Can you provide some insight on how you view the trajectory for this? Also, you mentioned that the cumulative beta remains relatively low. How do you see that changing as the rate cycle continues, particularly regarding both cumulative beta and the additional beta from future hikes?

I'll go ahead and take that. So, I mean, yes, we had deposit costs up 15 basis points from interest-bearing. I think it's important to add that when you include our very solid DDA growth really the all-in growth in deposit costs was 11 basis points. And that's been really and dramatic of the investments we have been making in that space to really drive DDA. And we are really proud to be able to continue to grow DDA in this environment which is better than many have been able to do. So that's the position we are in. We continue to see some opportunities to grow DDA going forward which will offset the interest-bearing cost as you indicated. Cumulative beta is around 28. I think you could see us getting into the low 30s in the second half of the year in terms of cumulative betas, even ending the year still in the low 30s. And sequentially betas, by the time you get to the end of the year, it depends on how many hikes you get, right? If you look out of the window and say, listen, there is a sense that we will get more at least but maybe not the second one, you could see sequential betas getting into the 50% or 60% level by the time you get to the end of the year really being driven by that at least one more hike that we think we will get either in September or November.

Obviously, you have the asset sensitivity in the mix shift, though the balance sheet optimization helping you, but is there a point at which the beta in terms of rates or betas that an incremental hike becomes NIM neutral?

Yes, just something to think about on the loan side, our loan betas are around 60% and continue to hold in at that level. When you think about deposit base, you've got to remember about all the non-interest-bearing funding including equity that needs to adjust that level. So even out a deposit beta at 60%, the effective beta is really 45%, and so it continues to be useful and accretive to grow into that kind of environment, and we're constantly looking at that on a quarter-to-quarter, month-to-month basis, and we monitor the incremental loan growth against the incremental deposit cost and we make financial decisions that are quite prudent in that regard. But I don't think we should be scared away from 60% deposit betas because of that other effect that I mentioned.

Yes, I would like to add to that. Looking at the overall asset sensitivity we published in response to 200 basis points of gradual hikes, we’re around a 5% level, slightly under that. This reinforces John's point about the current dynamic favoring NIM accretion as the Fed continues to raise rates. When we examine our deposit costs in comparison to a peer group of super-regional banks—some that are growing deposits, others that are stable, and some that are allowing their deposits to shrink while their loan-to-deposit ratios rise—it seems we’re performing quite well. We anticipate a slight increase in our interest-bearing deposit costs because we are growing deposits aligned with our loan growth. This positively impacts our expanding NIM and ROTCE, and I believe we are managing this calibration effectively.

Okay, that's helpful. And if I could just follow-up on the asset side, loan yields were up a lot this quarter, 33 bps and I think 40 plus for commercial, how much did the LIBOR blowing out relative to the Fed funds help and how should we think about asset yields and commercial loan yields I guess specifically with incremental hikes?

Yes, I mean that helps, right. So I mean we get 30-some basis points and that's a bit of help.

That was there last quarter though too. So that's been kind of on a sequential quarter basis, you've had the LIBOR anticipating the moves, and so it's relatively neutral I think from Q2 to Q3 because they both have that phenomenon.

They do, yes. So first quarter the phenomenon was really stronger than second quarter. And you saw three months LIBOR and one month LIBOR kind of tightening in a little bit, but Bruce is exactly right quarter-over-quarter, 1Q to 2Q similar phenomenon. As you head into 3Q, we're going to continue to get asset yield growth, but it will be more balanced with the consumer side of the house. In 2Q, you saw C&I really driving it in Q3, it will be more balanced between consumer and commercial. And the other thing to talk about, we still are in about even post swap adjusted basis with 52% of our assets are floating. But the other 48% continues to drive improvement when we get that - when you don't have the rate, I just take benefits from that, from the lag effect on the flipside of the asset block.

Okay. Just one final quickie, on the guidance for Franklin American, that 25 to 30, is that I guess we should think of that as a two-month impact and then as opposed…

Yes, roughly yes.

Hi, good morning. For Bruce or John, I wanted to ask about the CCAR outcome. In your press release, you expressed dissatisfaction with the result. Could you help us understand your perspective on the disconnect and what steps you're taking to engage in discussions regarding the models? I'd like to gain insight into the direction you're aiming for, especially since you have significant capital to return. Clarifying the outcome and outlook would be really helpful. Thank you.

Yes, Ken. We're having a private discussion with the Fed, and I'll give you the main point to help you understand our perspective. The Fed changed their PPNR model in the 2017 CCAR cycle, shifting from an average industry approach to a firm-specific one. They based this new model on data from just after the great recession, which we believe has some limitations. When you look at super-regional peers, most benefitted from TARP funding and were able to expand their balance sheets, and some made acquisitions that were quite beneficial. In contrast, Citizens was largely owned by the U.K. government, making us ineligible for TARP funding. As a result, we needed to reduce our balance sheet, particularly because our parent company had to raise capital. From its peak to its lowest point, Citizens' balance sheet decreased by 30%, while peers generally increased theirs; the average peer grew from 125 to 160, whereas we fell from 160 to 125 over five years. When a bank contracts like this, it impacts fixed costs, leading to an increased expense ratio which negatively affects PPNR. Therefore, if the Fed uses that data, they'll arrive at one conclusion for most banks but a different one for us due to our distinct history. Additionally, the Fed assumes that a bank's balance sheet will grow during their forecasts, not shrink, creating a mismatch between their assumptions and the data used for their PPNR model. That's the gist of it. We’ve been in ongoing conversations, and we’re optimistic because we think we have a clear, logical argument that has previously been considered and led to adjustments by the Fed. We hope this perspective resonates with them.

Understood, okay, thanks for that. Appreciate that. John, one question for you, there are a lot of focuses obviously on the right side of the balance sheet, can you help us understand how much more efficiency improvement do you have on the left side? You have talked about a lot of the things that you're working on in terms of the mix and the changes. But any tangible examples of where you still see an asset yield improvement that we may not be getting yet in the current results?

Yes, absolutely. So on the asset side, we think about it as reallocating capital from lower return categories. We missed a fair bit of that out there. We've got a relatively large auto book and an asset finance book and a non-core book that all tend to come in a bit lower on the risk-return profile than maybe some of the other opportunities that we have up there in the student space and emerging finance and all in within C&I. So there's still a fair bit of that to go, and you can't really fix that kind of stuff in one or two quarters; it takes years to be able to fully transform the balance sheet, and so we have embarked upon this with the level of formality and you will continue to see benefits coming out of that behavior over the next year or two. I would also mention we not only see opportunities across loan categories, but within loan categories themselves and where we want to rotate more return basically bottom quartile investments that we may have made and maybe increasing the velocity of exiting those relationships and rotating them into and reallocating the capital in different relationships is also an opportunity, and that's indicative of what we did with the $350 million that you saw in 2Q. So I think there's still a fair bit left to go on that front.

Got it. Okay, thanks a lot.

Great, thanks. Good morning. I guess, first question just in terms of the broader guidance, I certainly appreciate the third quarter guidance, it is very helpful, but when we think about like the full-year guidance that you had given a couple quarters ago, specifically loan growth I think was 4.5 to 5.5 and fee growth of over 4.5. Are those targets superseded by the third quarter, meaning should we no longer rely on the full-year targets you gave a few quarters ago? Thanks.

We provide annual guidance at the start of the year and follow up with quarterly updates, but we don’t revise the full-year guidance every quarter. You have two quarters completed and a detailed outlook for Q3, so we expect analysts to piece together predictions for the fourth quarter. Looking at our performance trends, especially in net interest income, I believe you can project that we will be near the upper end of our targets based on our Q3 results. While loan growth may be slightly less than initially expected, we anticipate better net interest margin expansions. Regarding fees, we might fall slightly below our range unless we account for Franklin American, which could bring us back within it. On expenses, we are staying within the anticipated range. When you combine all these factors, we expect a strong pre-provision net revenue consistent with our initial guidance for the year, and we see solid improvement in credit costs, giving us confidence in meeting our year-end targets.

Okay, great. That's helpful. And then, just in terms of Citizens Access. When we think about the growth there, and presumably they are coming at somewhat higher cost than your normal deposits, your branch-driven deposits. How does Citizens Access change? How do you feel about your asset sensitivity going forward?

Yes, I'll address that. We recently launched this initiative, and it's an important step in diversifying our revenue sources. It's worth noting that we aim to reach around $2 billion by year-end, which represents less than 2% of our total deposits. We are enthusiastic about this platform as it allows us to explore innovative customer experiences, but we want to keep its impact in perspective. In terms of costs, launch rates tend to be a bit higher to increase awareness and consideration, but they remain lower than our large commercial and consumer promotional rates and wholesale borrowings reflected on our balance sheet. This is critical both qualitatively and financially, as these types of deposits are valued additions to our balance sheet. Currently, even at our launch rate, we have around a 2% return on savings, which is a significant portion of our strategy. Larger commercial deposits typically exceed that, and compared to traditional branch promotions, which usually have higher rates due to cannibalization, our Citizens Access rates are competitive. Overall, we are excited about both the strategic and financial aspects of this initiative as it strengthens our balance sheet.

And I would just add, John, I think it gives us access to a whole new customer set and a customer base that we haven't had access to before. We are 11 days into the launch. We are optimistic about the progress we've made. And we have already taken deposits in all 50 states. So it's a good sign that we are reaching new customers.

All right. Great, thank you.

Good morning. Could you talk about your growth projections over 2019-2020, or maybe over the next three or four years for Citizens Access, given the structure of that and how much you expect it to grow, or at least be a portion of your overall deposit base?

Yes, I mean, I'd say this, I mean, it's hard to see where this goes, right, and so we will remain nimble as it relates to where we want this to head. But you wouldn't imagine that this thing would get out of a single-digit percentages of total deposits going forward, or maybe I guess into the five to at the very highest ten, but I would say a good expectation would be maybe high single-digits, but we are going to – like I said, we are going to test and learn. This is new for us, and we are excited about how things have launched you out of the gate. But it won't be a huge part of our deposit base over the next couple of years as we look out into the future.

Okay. And do you view this as an alternative to funding the typical branch deposit base in order to gain new customers and potentially grow assets through these new customers, or do you view this as like an alternative funding source to replace the wholesale funding?

Well, let me take that, but I would say that it is an alternative funding source that can be compared and contrasted with some of our higher-cost marginal dollars of funding. So what would those be? Certainly on the commercial side, we have pockets like borrowings from financial institutions or pooled government funds that you could look at the marginal cost of that versus using this channel. Certainly on the consumer side, the kind of promo CD pricing to cost new money from our existing customers into the bank, you could compare and contrast that versus this offering, which is much more diffuse and going to attract money on a much broader basis. And so that's principally how we would view it. Having said that, what Brad just said, I think it's quite important that the test and learn and enhancing our digital capabilities, and then can we offer additional products and services digitally to these customers. We have some very attractive lending products, for example, but maybe those customers would be interested in; we will see where it goes.

Okay. Thank you very much.

Good morning. I was hoping if you could just elaborate on the appetite for some of the fee revenue deals, and then, specifically in mortgage, do you feel like you've got the scale on the servicing side that you want there, or is that an area of opportunities though?

I would start here and say, you know, I think the areas where we haven't had the scale, the biggest holes really have been on the consumer side fee activities. The first was mortgage. I think this really addressed what we feel we needed. So I don't think there is really more we need to do in mortgage. The second area has been wealth, and we've been building that organically getting the business model right in terms of how we distribute through our branches and become trusted advisors to a much broader swath of our client base. We are missing some opportunities I would say at the highest end of the pyramid, and the cross-sell over into commercial, where we offer great banking services to some middle-market companies and very wealthy families. But we really don't have that high-end capability that competes well in the marketplace with some others. And so, that might be an area for example where we look to do an acquisition or other things in the footprint that can potentially get us more breadth and get us a bigger financial consultant for us faster than doing it organically. So those will be the areas on the consumer side. I'd say on the commercial side, we did the M&A boutique. We still have opportunity, I think based on the size of our customer base to expand that, and so we might build off that platform and hire organically, or if we can find some other boutiques that maybe cover certain industry verticals, we could seek to bolt-on that way to that platform. I think there are opportunities potentially around the payment space and some of the innovation that's taking place there. Some of those things could be through FinTech, some of those things could potentially open opportunities for acquisitions, but I think we are now feeling good about our capability to source deals due to diligence, execute them well. That was kind of muscle that we didn't have, we didn't need; we haven't done a deal prior to one last year, and I guess it was 13 years, I think 2004 was the Charter 1 deal. But now we've got the capability inside the bank, and we feel good about our opportunity to source these things, put them in. I think they're going to be straight down the fairway modest in size, fit a strategic need and have good financials associated with them.

Okay, that's helpful. Thank you.

Yes, good morning. I just had a few follow-up questions; Bruce it's been really impressive to see the ROTCE improvement and what's really stunning is even you look to do that with the CET1 ratio just essentially flat lining at 11.2%, and I'm wondering given the 290 basis points difference between the co-run model and the Fed model like Ken was mentioned in his line of questioning, if there is not a significant amount of improvement in terms of the difference in modeling, what kind of flexibility do you have over the near-term to take that down on an organic basis in terms of your CET1 ratio?

We still have a fair amount of flexibility and are aiming to reduce that by 40 to 50 basis points this year, especially in light of the Franklin American deal. Looking ahead to next year, the SCB is expected to take effect, but even if the issue remains unresolved, we have enough flexibility to continue our progress. I don't anticipate much impact at this point. It does affect perceptions of our performance, especially when we see ourselves alongside firms like Goldman Sachs and Morgan Stanley with high stress losses, which seems unreasonable. It’s beneficial for us to have the results adjusted and to align more closely with our peers, particularly as our ROTCE is now converging with theirs. The projected PPNR impacts from the Fed shouldn't be as significant as they suggest. My main concern is to get this issue rectified, as it negatively affects our reputation. In the long run, fixing this could provide us with additional flexibility if needed, but for now, we are confident in the glide path we are on and will continue executing that through the next CCAR cycle, then reevaluate after a year.

Got it. And a follow-up question for you, John, I think what Bill was asking is in other conference calls that we've heard through this earnings season, the CFOs have indicated that the each net subsequent 25 basis points of rate hike will be less impacted on NIM as the previous. And I just wanted to make sure that we're hearing you right that because of the DDA growth and continued optimization on the asset side that you believe that Citizens is going to buck that trend?

I wouldn't say that, Erika. I would definitely say that we agree each 25 basis points increase in the Fed does drive an equal increase in the sequential data. That's clear. Additionally, we are growing DDA in an environment where most are not, which is helping us on a net basis. It's having a somewhat offsetting impact, but it doesn't fully reverse the effect of the fact that sequential betas will grow. We will experience growth in sequential betas like others, but not to the same extent if we don't grow in DDA.

Got it. Thank you.

Good morning.

Hi.

I was curious about the commercial real estate lending environment, you guys are still having very good growth, and we've heard from a number of banks this earnings that probably getting more cautious on commercial real estate just given pricing and loosening of underwriting. I'm just wondering what you're seeing.

Yes, we definitely are also getting at the margin more cautious and being more selective where we see terms and conditions being stretched. We haven't seen that much movement in price in terms of price deterioration, but we have seen a little bit of move in leverage and structure, and we are staying disciplined. The other thing that you're seeing in some of our real estate growth is we have a large construction book, which is funding. So it's transactions that we have put in place on an unfunded construction standpoint several years ago which are funding up onto the balance sheet right now. So I would say a growth on the origination side we think will moderate a little bit, but it wouldn't necessarily mean that our growth on the asset side will moderate on the funding effect.

Thanks. And just a follow-up question, could you just talk a little bit about the impact of the flattening yield curve on your margin, and are there steps you could take to offset some of that pressure?

Yes, I'm going to take that one. And I think the way to think about our exposure there is that we're about 75% and this is short end of the curve. But when we have a flattening yield curve, then that can give you a sense for what opportunity cost area is. That would otherwise be the case, as that non-occurred. So we got a 4.6% asset sensitivity number that we spoke about earlier, that assumes the parallel shift increase in rate. So you note 25% half off of that when we don't get that increase on the long end. It's hard to fight gravity on the long end of the yield curve, and we are sensitive to the short end and maintain a majority exposure to the short end, and a lot of our C&I lending really drives that exposure, and that's really the best defense, I guess I would say, to continue to drive net interest margin in an environment where the Fed continues to move, but the long end remains certainly well.

Thanks.

Thank you. Good morning. Bruce, you talked about the CCAR and the discussions you've had with the Fed. Obviously with the reform to Dodd-Frank, you guys will be falling on a CCAR possibly as soon as next year if not the following year. Aside from the obvious headlines, it's not going to be in the news anymore, what do you think, or how are you guys thinking you will maybe behave differently not having to go through the formal process? Will you be able to give back more capital quicker? What's your thinking on that?

Well, I'd say – let me just emphasize that I think stress testing is a very valuable exercise, and it's embedded in our bank and every other super-regional. We have it basically built into our risk appetite framework, and it's tied to our strategies. So when we make decisions in terms of where we're allocating our capital, we run it through our stress test to ensure that we're making wise decisions. So just want to make that point first off, Gerard, is that if you fall out of the public exercise you're still going to be doing stress testing because they're quite valuable in terms of how you're running the bank. I think if we're not in that public exercise I think you just gain back time and maybe some effort in terms of how you have to package things up and present them, but we'll still have examiners on our local teams who are going to want to see how we're doing those exercises, it might be a little bit of time and effort savings. I think the big thing that you gain probably is just a little more flexibility where the management team regains control over making those capital decisions, and it's not a once-a-year exercise. That would sure be great for example if you forecast that you're going to have 5% loan growth, if the loan growth comes in at 4%, you don't have to go through a whole resubmission; you'd simply be able to say, "Okay, so my capital building up a little bit. I can go back and buy some more stock, and I can neutralize the impact of not having the loan growth that I assumed." And so I think that's the thing that we look forward to is to kind of start to operate the way normal companies do and normal industries not having to go through the full mother may I exercise that we have to today.

And just to add to that, Gerard, as Bruce mentioned earlier, even if we don't get out of the stress test regime, the SCB has some really intriguing and desirable attributes from a flexibility perspective. So you will forget some maybe even most, but not all of the flexibility you would get if you get out entirely; you would still have the uncertainty factor of the annual SCB it would be assigned but you would get back a lot of the flexibility maybe even in the near-term even before we get out of the test itself.

Very good. I'm encouraged with Vice Chairman's quarrel speech this week that hopefully all you guys will benefit from the changes that are coming. And as a follow-up, obviously it's brand new; you guys just rolled out your national and digital strategy, Citizen's Access, in your thinking, do you think this business will be more competitive versus your – I know you're in a day-to-day blocking and tackling businesses, very competitive in your footprint, do you guys have a view on which one is more competitive, or are they just really just very both competitive?

I will start off, and frankly, maybe Brad can add. I think on a pricing standpoint, they both seem to be very competitive. I mean when you look at the branch of footprint activities, and talking earlier about when you think about TOP online and direct bank offers being around those call at the 175 to 200 basis points range for savings, even in branch businesses which have all of the physical cost associated with it, we're seeing in our footprint, competitors going out at 175, which is at the low end of the online bank with no legacy physical plan that you have to recover as well. So the competition is pretty stiff in both places. We just have to pick our spots. And I think we've done that well in terms of differentiating on customer experience, and we've got one of the best customer experiences we believe that's out there, and Brad can elaborate that, but being clear about how we target the level of growth and where we invest funds, I'll turn it over to Brad.

John, I think you've absolutely right. They're just different, right. They're both very competitive; they're just different. I can't stress enough that it is a completely different customer segment. So you really have to understand the customer that's using the direct bank. It's a different customer. It is highly competitive. You win on customer experience, which we think ours is exceptional, and you win with data and analytics capability and having sophisticated ways of reaching the customers. And we think we're very good at that as well. So we think we can win in both places, but in terms of which is more competitive I think they're equally competitive.

When you guys did your analysis and your work before you launched it, what was your conclusion on what percentage of customers if they choose to purchase one of your products, is it rate-driven, what percentage of that customer is driven to your product just because of the rate?

Let me approach that question a bit differently because I'm not certain I can specify what percentage is rate-driven. Our research indicates that customers using direct banks tend to be digitally savvy and prefer online shopping. While there is certainly a rate component, they also seek a very straightforward experience and expect low fees. Additionally, the cost to run a direct bank is significantly lower. We have introduced a direct bank with no fees and a very simple experience.

You can open an account under…

You can open and fund an account in less than five minutes. So again, it's a different customer. They are rate sensitive, but I think what they really are looking for is a simple experience.

And Gerard, I think you're in our footprint, so you might want to try it out.

We'd love to have you open an account.

Absolutely, I will and I'll report back. Thank you so much guys.

Okay, great. Thanks again everyone for dialing in today. We certainly appreciate your interest and your support. We continue to execute well, and we maintain a positive outlook for the balance of 2018. Thanks again, and have a great day.