Citizens Financial Group Inc (CFG) — Q4 2018 Earnings Call Transcript

Thanks so much, Brad. Happy 2019 everybody. Thanks so much for joining us this morning. Our earnings release, presentation, and financial supplement are available at investor.citizensbank.com. Chairman and CEO, Bruce Van Saun; and CFO, John Woods, will provide an overview of our fourth quarter and full year results along with our outlook for the year and then we will open the call for questions. Once again, we're pleased to have Brad Conner, Head of Consumer Banking and Don McCree, Head of Commercial Banking with us today. And of course, I'm required to remind you that our comments will include forward-looking statements that are subject to risks and uncertainties, and information about the factors that may cause our results to differ materially from expectations, and can be found in our SEC filings, including the Form 8-K filed today. We'd also utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our filings. And with that, it's all yours, Bruce.

Thanks, Ellen. Good morning, everyone, and thanks for joining our call. We're pleased to report another strong quarter today, with underlying net income up 36% and diluted EPS up 38% year-over-year. These results were paced by solid loan growth of 5% year-on-year, continued NIM expansion, which combined with good expense discipline drove 5% underlying positive operating leverage, excluding Franklin American Mortgage acquisition. Our underlying ROTCE improved to 14.1%. The underlying efficiency ratio dropped to 56.7%. Our success in hitting our new medium-term financial targets has led us to raise them again, which we will cover later in the call. For the full year, our results were also strong. Underlying net income was up 32%, and diluted earnings per share was up 38%. Our PPNR growth was 13%. We consistently exceeded expectations each quarter during the year given our disciplined execution along with favorability on credit. We feel very positive about the accomplishments in progress that we made in 2018. Some of the highlights from my perspective include: first, strong execution of our TOP and our BSO programs; we had excellent progress on our customer, colleague and community agendas; we had some really strong technology innovation, including the launch of Citizens Access, reaching 10 fintech partnerships and great momentum on our digital and data agenda; acceleration of our branch transformation effort with 109 branch actions delivered; and also the smooth opening of our new campus in Johnston, Rhode Island. We made two smart fee-based acquisitions, Franklin American Mortgage and Clarfeld Financial Advisors, and we delivered strong returns of capital to shareholders including two dividend increases with a dividend now up 45% year-on-year. We also added some great talent to the company including Ned Kelly and Terry Lillis to the board, and Michael Ruttledge, recently, as our new Head of Technology. Now as with many peer banks, there is a disconnect between our progress in the field and our stock price in 2018, but that said, we are focused on what we can control and our expectation is that if we continue to execute well, run the bank better and better and make the right investments to grow our franchise value, then the stock will recover and better reflect our true value. The market's been concerned with the possibility of recession and rising credit costs. Our view is that a recession is unlikely in '19 or '20, and the economy is on a sound footing. We have been highly disciplined in the process of growing our balance sheet and our expectation is that we will perform better than the median super regional in the next downturn. We did moderate our loan growth somewhat in 2018 relative to our beginning of the year outlook, and we've steered away from riskier lending on both the commercial and consumer sides. During the choppy Q4 loan markets, we did not take any underwriting losses or have any hung deals. We've provided our usual detailed guidance for 2019 in our slide deck, which John will cover in a few minutes. The blueprint will seem very familiar, reasonable loan growth, some NIM expansion, better growth on fees, good expense discipline and positive operating leverage. Credit provision, while normalizing somewhat, should remain well behaved. And we will continue to prudently manage our capital base. So in summary, our expectation is for another year of good execution and further progress across the board. With that, let me turn it over to John.

Thanks, Bruce. And good morning, everyone. We're pleased to report another strong quarter with improving results and a great finish to a year marked by steady execution and significant progress against our targets. We continue to run the bank better, and we are entering 2019 with nice momentum. I'll touch on some of the slides in our earnings presentation. So if you pull those up, it may assist in following along. Some highlights for the quarter are shown on Page 4. We grew our underlying EPS 38% year-on-year. We continued delivering robust positive operating leverage 5% year-on-year, excluding the impact of the Franklin American Mortgage acquisition. And we did this while making the long-term investments required for sustainable success. We continued to make progress on improving returns with underlying ROTCE for the quarter of 14.1%, up 61 basis points linked quarter and 3.7% year-over-year. We continue to focus on growing our customer base and loan portfolios across our Consumer and Commercial businesses, while also expanding and investing in our fee-based capabilities. This has led to consistently strong revenue growth. We have been disciplined on expenses giving our TOP programs and mindset of continuous improvement. This has created the capacity to make significant investments in technology, digital, data and customer experience, which positions us well for the future. This plan and our ability to execute provide a strong foundation and outlook for 2019. On Page 5, we provide information on some notable items this quarter, including the impact of an additional $29 million benefit tied to 2017 tax legislation. This was partially offset by other notable items totaling $26 million after-tax, largely associated with TOP V, including several real estate initiatives such as accelerated branch closures. We also recorded $12 million of after-tax integration costs related to the Franklin American acquisition. In order to make it easier to see our core trends, we will largely focus on our results without these notable items. On Page 7, you can see that we delivered underlying positive operating leverage of 5% excluding the impact of Franklin. We also delivered an underlying efficiency ratio just under 57%. And our underlying PPNR growth year-over-year was 13% excluding Franklin. Moving to Page 10. We are pleased that despite a fairly competitive landscape, we continued to drive disciplined balance sheet growth and delivered a 2% sequential quarter increase in net interest income. And our net interest margin increased 3 basis points in the quarter, reflecting continued expansion in earning asset yields, with deposit costs in line with our expectations. Turning to fees on Page 11. Underlying fees increased $10 million despite a challenging market environment in the fourth quarter. This was driven by strength in global markets and the full quarter effect of Franklin. In global markets, FX generated excellent results up 16% quarter-over-quarter, due to elevated customer activity against a volatile but mostly range-bound U.S. dollar index. Our capital market fees were relatively flat linked quarter despite some major volatility and disruption in the loan and debt markets. Our loan syndications fees were up 20% linked quarter with very strong volumes leading to a record number of lead and joint lead transactions for the fourth quarter and the year. This was offset by lower bond underwriting fees given limited issuance in November and December. Additionally, we had a strong quarter and M&A revenue as we gained leverage from our Western Reserve Partners acquisition. On the Consumer side of the house, we now have a full quarter of fees from Franklin and the integration is on track. We also saw continued traction in our Wealth business with a 4% linked-quarter increase in managed money revenues and 19% growth year-over-year. On Page 12, we continue to focus on balancing expense discipline with the need to fund investments to drive future revenue growth. As a result, excluding the impact of Franklin, linked quarter expenses were down $5 million, reflecting the benefit of a decrease in FDIC insurance expense. We utilized some of this benefit to fund strategic growth initiatives while maintaining strong expense discipline overall. Let's move on to Page 13 and discuss the balance sheet. We continue to focus on prudently growing our balance sheet in a fairly competitive environment. We saw some nice growth in commercial loans in our industry verticals and in our geographic expansion areas. We remain very selective about CRE but are still finding some attractive opportunities for growth in areas like tenant-secured office and industrial distribution facilities. On the retail side, we continue to see good traction in some of our attractive risk-adjusted return categories like education and unsecured as well as important categories like mortgage. Overall, we grew core loans by 2% linked quarter and 5% year-over-year, notwithstanding the impact from the planned runoff in auto, noncore and leasing, which was around $1.7 billion or 1.5% year-over-year. Core loan yields improved by 14 basis points in the quarter, which was ahead of the 11 basis point improvement we saw in the third quarter. We continue to see good results from our balance sheet optimization efforts, which in the quarter delivered about 4 basis points of 14 basis points of margin improvement year-over-year before the impact of Franklin. Turning to Page 14. I am pleased with what we were able to accomplish in deposits this quarter. We continue to do a nice job of growing deposits, which were up 1% linked quarter and 4% year-over-year. In particular, we continue to see gains in DDA balances, which were up about 3% year-on-year and approximately 1% before the impact of Franklin. This is the sixth consecutive quarter we have grown DDA on a year-over-year basis. This growth is led by strength on the consumer side where our deposit initiatives are really paying off and DDA balances are up 4.5% year-on-year, excluding Franklin. Our total deposit costs were well controlled, up 9 basis points, which was better than the 10 basis points we saw last quarter. Interest-bearing deposit costs rose at a slower pace again this quarter, increasing 12 basis points compared with a 14 basis point increase in the third quarter and 15 basis point increase in the second quarter. Our cumulative beta on interest-bearing deposits is in the mid-30s, as expected, and remains in line with our overall expectations given where we are in the rate cycle. We are benefiting from investments we've been making in Consumer that began back in 2016 in areas like enhancing our product suite, improving the customer experience through our customer journeys work and in analytics to improve our customer targeting. In Commercial, we are making investments to build out additional product capabilities like escrow services and are rolling out our new cash management platform in 2019. Also, Citizens Access has contributed nicely to our funding diversification and optimization of deposit levels and costs. By year-end, we reached about $3 billion in deposits, having launched in mid-July. While this remains a relatively modest part of our overall deposit strategy, we continue to be very pleased with the progress so far. We now have over 30,000 customers through Citizens Access, with 96% of these deposits from new deposit customers and the average account size is about $72,000. Year-over-year, our asset yields expanded 55 basis points, reflecting the benefit of higher rates and the impact of our BSO initiatives. Our total cost of funds was up 44 basis points, reflecting the impact of higher rates and a continued shift to greater long-term funding. This included the impact of the $750 million senior debt issuance late in the first quarter of 2018. Next, let's move to Page 15 and cover credit. Overall, credit quality continues to be excellent, reflecting the continued mix shift towards higher-quality, lower-risk retail loans and an improving risk profile in our commercial book. The nonperforming loan ratio improved to 68 basis points of loans this quarter, down from 79 basis points a year ago. The net charge-off rate of 29 basis points for the fourth quarter was relatively stable linked quarter and year-over-year. Retail net charge-offs reflect improvement in auto, which helped offset expected seasoning in the unsecured portfolio. Commercial net charge-offs for the fourth quarter were up modestly compared with the prior year, which benefited from higher recoveries. Overall, we feel good about credit metrics and trends in the book including a continued decline in criticized asset levels. Our allowance to loans coverage ratio ended the quarter at 1.06%, reflecting continued improvement in the loan mix towards higher-quality retail portfolios and improved rating agency-equivalent risk ratings in Commercial. The NPL coverage ratio improved to 156% as we saw a 4% reduction in NPLs linked quarter with continued runoff in the noncore portfolio. Investors continued to be worried about a challenging macroeconomic environment and the potential for increased credit costs, but we continue to feel good about our risk management talent and profile, and our overall credit quality trends continue to be variable. We've included some good slides on Page 27 through 31 from a recent conference presentation on this topic, in case you missed them. On Page 16, we continue to maintain strong capital and liquidity positions, ending the quarter with a CET1 ratio of 10.6% compared to 10.8% in the third quarter. This quarter, we repurchased $300 million of common stock and returned a total of $427 million to shareholders including dividends. Our Board of Directors has declared a dividend of $0.32 a share, which is a 19% increase over the prior quarter. With this increase, the dividend is now 45% higher than it was a year ago. Our achievements against our enterprise-wide initiatives are highlighted on Page 17. We continue to make traction on our balance sheet optimization efforts as we recycle capital out of lower-return categories like auto and leasing, where the core yields have improved and the portfolios have increased significantly, and we redeployed that capital against higher-return categories like our education refinance and Merchant Finance portfolios as well as in higher-return relationships in Commercial. Balance sheet optimization contributed 5 basis points of our 17 basis points full year 2018 versus 2017 margin improvement. Additionally, we continue to deliver beyond expectations in our TOP programs, where we now expect TOP IV to deliver about $115 million in pretax run rate benefits. As we work on expanding our capabilities, in Consumer we completed the acquisition of Clarfeld Financial Advisors. Clarfeld provides a unique opportunity to accelerate our strategy of building a highly competitive wealth management business to serve some of the most affluent markets in the country where we operate. They have sophisticated high net worth and ultra high net worth offerings that will really complement our wealth platform. Most noteworthy in the quarter on the commercial side is the launch of commodities hedging services as well as a modest high-yield sales and trading operation. Given a further tax benefit from the 2017 tax legislation, we were able to accelerate a number of our efficiency initiatives including a significant acceleration of our branch modernization efforts. And as we bring TOP IV to a successful close, our TOP V initiatives are well underway. Bottom line, we've been able to successfully lean forward with our longer-term strategy while also executing well and delivering strong results in the near term. On Page 18, you can see the steady and impressive progress we are making against our financial targets. This quarter, we hit the middle of the range of our 13% to 15% medium-term ROTCE target set in January 2018. Since the third quarter of '13, our ROTCE has improved from 4.3% to 14.1% underlying and our efficiency ratio has improved by 11 percentage points from 68% to 57% and EPS continues on a very strong trajectory as well up to $0.98 on an underlying basis from $0.26. On Page 19, we review our full year performance against the guidance we provided at the start of 2018 as it's always good to hold ourselves accountable. You can see mostly green ticks on the right column demonstrating another year of strong execution against the backdrop of slower loan growth across the industry. We remain focused on improving the fee income line through both organic initiatives to expand capabilities as well as through smart targeted acquisitions. On Page 20, we detail our guidance for 2019. Quite similar to 2018, with good top line growth, a 3% underlying positive operating leverage target excluding Franklin and Clarfeld, further efficiency ratio improvement and capital normalization. A few points of color. We expect reasonably strong loan growth similar to 2018 in the range of 3.5% given the unique opportunities to capitalize investments in people and products. Growth will continue to be focused in the areas we believe offer attractive risk-adjusted returns. We project NIM to be of low to mid-single digits despite no short rate increases on the forecast and a flattish curve. This reflects continued execution of our balance sheet optimization efforts. We expect continued growth in noninterest income in the 11% to 13% range as we leverage our investments and expand the capabilities and continue to invest for the future. This is 4% to 6%, excluding the impact of Franklin and Clarfeld. We expect credit quality to remain well controlled with provision normalizing towards the range of $400 million to $450 million. We expect our CET1 at the end of the year to be around 10.2% with a dividend payout ratio in the range of 30% to 35%. Our outlook for the first quarter is on page 21 and it reflects continued momentum in both our top and bottom line results. The first quarter is typically a seasonally softer quarter for us given several factors, including day count, seasonal activity levels and FICA taxes associated with incentive compensation. We expect linked quarter average loan growth to be around 1% given strong commercial lending pipelines and solid growth in education and retail unsecured. We expect NIM and NII to be broadly stable reflecting no rate hike and no impact on NII. Noninterest income should be broadly stable as a rebound in capital market fees is expected to offset seasonal impacts. We expect noninterest expense to be up in the low to mid-single digits given seasonal factors like FICA taxes on incentives. In addition, we expect provision expense to remain relatively stable. And finally, we expect to manage our CET1 ratio to end the first quarter around 10.5%. Overall, our view for the quarter reflects continued strong execution against our plan. So now, let me turn it back to Bruce.

Thanks, John. Turning to Page 22. Let's shift gears and focus on where we're taking Citizens over the medium term. We have a mission to really make a difference for our customers, colleagues, and communities so that they can reach their potential. Banks that can deliver this will build long-term franchise value and stand out in a crowded banking landscape. And we are committed to getting the balance right between building long-term franchise value while also delivering consistent earnings growth and attractive returns. The bottom of the page shows where we will differentiate to be successful. First off is our culture. We have a very powerful customer-centric culture. Next is our discipline around how we're trying to run the bank better each and every day. I think our financial and operating discipline is fairly unique amongst the regional banks. And lastly, we are committed to excellence being a trusted advisor, having great leaders, having great digital capabilities, a great ability to use data, those things that will really distinguish us. On Page 23, let me identify some of the keys to taking our financial performance to the next level. There are three things that I would point to that are listed here on this page. First, what's gotten us this far are the same things that should propel us further. So having a top leadership team, having a good game plan, a good ability to execute and make the investments that position us for long-term growth, those things will continue to propel us forward. I look at what we've accomplished over the past five years as a great foundation for an even better next five years. Next, the enterprise-wide initiatives like our TOP program and our balance sheet optimization program still have a good amount of running room, and they are fairly differentiating for us relative to our peers. And then lastly, we're doing a very good job of not only delivering and putting points on the board with our short-term execution, but we're spending a lot of time thinking about our long-term strategy, thinking about what's changing in the banking environment, what's changing in technology, what are the investments we need to make to continue to be successful and position us to drive strong franchise value. And it boils down to some extent to a growth mindset, to look for those opportunities where we can find new revenue pools, new ways of doing business, new ways of serving customers, and we feel good about our ability to do just that. On Page 24, we present our new medium-term financial targets. You can see that we've outlined our expectations for the overall economic environment, which is relatively constructive. Over the medium term, we expect to deliver continued improvement in ROTCE, moving our target range up by 1% to 14% to 16%. We are not expecting much in the way of further rate increases and while GDP growth will slow relative to 2018, we do not expect a recession anytime soon. The key to the continued ROTCE improvement is continuing to deliver positive operating leverage, and our TOP and BSO will be appointed to this given the potential for fewer tailwinds from the environment. We expect to see continued efficiency ratio improvement down towards 54%, we also expect to see some normalization in credit from the excellent performance that we're seeing today. And we continue to be focused on returning capital to our shareholders through our repurchase program and targeting a dividend payout of 35% to 40%. Over this time frame, we would expect to reduce our CET1 ratio towards our target of around 10%. So to sum up, on Page 25, we feel that we've delivered strong results in Q4 and for the full year 2018. We are focused on growing the bank in profitable and sustainable ways and we will continue to deliver improved efficiency and effectiveness. We feel our balance sheet remains robust and our credit position is in great shape. And as we head into 2019, we feel very good about our ability to grow the business and drive towards our new targets. As you know, we've been a public company now for about 4 years. At the outset, we had a lot of work to do to address the issues that arose from the challenges faced by RBS. Today, the feeling inside Citizens is that we've turned the corner. We've addressed many of the challenges we faced at our IPO. We have demonstrated our ability to set a course, develop a plan, and execute that plan. We have a long-standing effort to drive ROTCE higher, drive our efficiency ratio down, normalize the capital ratio and grow EPS. And we have made good steady progress on that path, quarter in and quarter out. We are now in a new phase that we're calling Aiming For Excellence, on our way towards becoming a top-performing regional bank. So with that, Operator, let's open it up for some questions.

Let's see. For the first question, there was some variability in the fees during the fourth quarter due to disruption in the capital markets, but it appears you gained traction in most of the other key areas. As you look ahead to 2019, within your guidance, could either John or Bruce discuss the characteristics and primary factors you anticipate will drive you toward your full-year target?

Yes. I'll start, John, you can offer additional color. But I think the first area that will really power the kind of underlying 4% to 6% fee growth that we have excluding Franklin and Clarfeld is a bounce-back year in Capital Markets. So we see good pipelines going into the first quarter. The bond markets are starting to loosen and so I think we'll see some good revenues coming out of loan syndications. I think we've got really good traction now in our M&A business. We're doing a good job of cross-selling the Western Reserve capabilities into our customer base, so we feel good about that. Our Global Markets FX and IRP capability continues to grow. We're doing more than we did under RBS. We're doing a good job of penetrating the customer base. So those would be, I think, the key drivers on the commercial side. We are rolling out a new cash management platform so we have ambitions to also pick up the growth a bit in Treasury Solutions. On the Consumer side, I think Wealth is well positioned for success this year. We've made, I think, the right investments to get the right size of the sales force in place, the right approach to selling, the right product capability. We're doing more managed money sales. So I think we have a very good outlook for underlying wealth even excluding what we're doing with Clarfeld. And then our card business also, I think, we're going to make some progress. We have reinvigorated that a little bit and we're starting to see some signs of growth there. Anything you'd like to add, John?

Yes, no, I think you pretty much covered the highlights. I think the key message being that even without the deals, Clarfeld and Franklin, we're seeing nice growth and then you will see the full year effects of both Franklin and Clarfeld that you'll see that's also built into our guidance. But I think you hit the important points without Franklin and Clarfeld on both Commercial and Consumer.

Perfect. And then separately appreciate the new medium-term targets. I had one quick question on the updated capital ratios. So just if I look at things, you guys, obviously, have a very robust starting point. Just curious as you're looking at refreshing the targets if there's any thought to becoming perhaps even a bit more aggressive than the 10% CET1 target? And just overall what the thinking was in how you arrived at 10% as the appropriate number?

Yes, last January, our target range was 10% to 10.25%. We have removed the 10.25% and now set our target at 10%. I believe we are in a transition period where regional banks might aim to lower their capital ratios slightly. The Fed's proposal is out, and as we've mentioned before, we don’t see any reason we can’t operate at the median of our peers. If that median moves down to 9.5%, we could consider adjusting our target over time to align with our peers. Thus, keeping it at 10% might be a bit conservative, but that’s where we are for now. If we were to operate with slightly more leverage, it could positively influence our ROTCE.

Yes, it's okay. Maybe just add that I think it served us well to have this gradual glide path that we've been on. Given that, as Bruce mentioned earlier, we just went IPO 4 years ago, and we continue to find new opportunities to deploy capital, which is clearly our primary goal to deploy capital in excess of cost of capital and so whether that's through loan growth or targeted fee-based acquisitions, we've been pleased with the flexibility that this glide path has created for us. So we'll continue to balance that as we look towards that target.

So, Bruce, we understand that you've indicated your stock tends to experience a greater discount when the market is concerned about a recession, and we value the historical data you provided. Given that everyone's credit quality appears strong at the moment and that the underlying FICO scores are comparable across your competitors, could you offer us some additional insight? You mentioned that you became a public company four years ago, so could you share your perspective on the progress you've made since emerging from RBS and how that has influenced your growth rates compared to peers?

Yes, sure, Erika. I'll start with that point first and there's a good slide in the appendix that shows that as RBS ran into its challenges and needed to raise capital levels, Citizens being owned by RBS had to run down its assets, did not receive TARP funding. And so when you ultimately delever and you're in a high fixed-cost business, it really hurts your profitability. So part of our strategy here in recovering the bank's profitability was we needed to grow assets and gain that leverage back. And I think we've done that in a very, very disciplined way. On the Consumer side, we've decided to grow our mortgage business, which brings two things. It brings fees, but it also brings high-quality assets. But then we also look for some niches like education refinance loans, where we're one of the leaders, if not the leader, in the market, which is I think a very great product, a, for the borrower and for society but also good for us in terms of risk-adjusted returns. And then our merchant financing partnerships with Apple and others and stay tuned, more to come, those also I think offer very good risk-adjusted returns and we have typically a loss-sharing arrangement with our partner. So I feel really good on the Consumer side that we've been disciplined and we've had a desire to grow but we've been very careful in where we're growing. And then on the Commercial side, similarly, we've scaled up the business by hiring some great bankers. We've got really good credit people, starting with Don, who is here with me in the room but also on our credit team. And so I think we've brought over some new relationships to the bank that come with the bankers that we hire, the seasoned bankers that we hired. So we've grown in our industry verticals, which tend to be bigger companies, which tend to be better credits and when we've gone into new regions, we tend to focus on the bigger companies there as well, which tend to be higher-quality credit. So another slide in the appendix shows that even just over the past year, the quality of the credit book in Commercial and in Consumer has improved. So we are not growing for growth's sake. We're growing in very disciplined fashion, both on the Commercial side and the Consumer side.

And my follow-up question is as we think about net interest margin dynamics, looking forward, if the Fed is on a prolonged pause, how should we think about the dynamics beyond 1Q '19? And typically in your previous observations, how many quarters after the last rate hike does deposit repricing start really tapering off?

Yes, I'll take that one. It's challenging to determine the exact timing, but we estimate that it will take around 6 to 12 months after the final Fed hike for deposit costs to start adjusting downwards, initially at a higher pace that gradually slows over the first year. It's important to consider that our portfolio is roughly 50% floating and 50% fixed. Even if the Fed does not raise rates further, we still have the fixed portion repricing over time, assuming loan rates remain stable. This is why we are optimistic about our ability to drive net interest margin growth due to our organizational structure. Additionally, our management actions and BSO will contribute to maintaining our confidence in achieving continued NIM growth moving forward.

I want to follow up on the asset quality question because I agree with Erica; the bottom line is that you've been delivering very strong results. In a selloff, people tend to worry about your credit quality, even though all the metrics are strong. The slide on Page 28 that demonstrates the improvement in the commercial book quality is helpful. However, there isn't much focus on leveraged lending, which may not be well understood in terms of the risk it presents. Could you provide more detail about how you manage risk in the commercial book? How involved are you, Bruce, especially when considering some of the larger credits? Also, how can you address the perception that seems to be overstated in my view?

Yes, I agree with you, Matt. Let me begin, and then Don can add more insight. At the top level, we aim for diversity and detail in our credit exposures. We maintain a strict limit on leveraged lending and work to maximize our throughput within that limit. Our goal with sponsored leveraged loans is to support long-standing clients whom we trust are strong operators, helping them finance their desired deals while limiting our holdings. We view this as an originate-to-distribute model and have been quite successful in this approach. In the fourth quarter, for instance, when the markets faced challenges, we avoided underwriting losses and didn’t encounter any hung deals. We have a good understanding of market conditions. Another area of interest is Commercial Real Estate, which is often a concern that requires focus on overall limits and exposure. We currently have a limit that is significantly lower than our peers, as demonstrated in a slide in the appendix. It’s essential to maintain a granular approach, ensuring we’re not heavily invested in any specific class, such as office or multifamily. We also prioritize geographic diversity and continue to engage strong operators we've known for years. We apply the same disciplined approach to Commercial Real Estate as we do with leveraged loans. This really comes down to our people and leadership. I have great confidence in Don and the entire credit team, with Rob Allen managing commercial credit and bringing significant experience. Achieving solid results in the CCAR assessments places us in a median position. Therefore, it doesn’t seem reasonable for people to excessively worry about our credit risk given that we are a relatively new company. With that, I’ll pass it over to Don.

Yes, I believe you covered most of the key points, Bruce. It primarily starts with declining selection, especially since we have established relationships with most of our sponsors and corporate clients. As Bruce mentioned, our margin growth in expanding regions tends to involve larger companies, and we've intentionally avoided the middle market in these areas due to concerns over adverse selection if conditions become unstable. We're focusing on stronger, more agile larger companies. Additionally, Bruce highlighted origination for distribution. Almost everything in our risk sector is distributed extensively. There has been much discussion about nonbanks gaining market share from banks, which reflects where much of the residual risk lies within leveraged lending portfolios. Our holdings in leverage lending are very targeted, typically in the $10 million range. The services we provide to our clients are diversifying, enabling us to pursue multi-product business with each banking client. The addition of Western Reserve and our new securities capabilities allow us to distribute effectively in both loan and bond markets. Our ability to offer risk management solutions, including hedging in foreign exchange and interest rates, increases our relevance with clients and enhances our understanding of their needs. We're also exploring patterns in our payments business, which may serve as early-warning signs for potential issues in companies. Additionally, we've established a restructuring business to assist clients in adjusting their balance sheets if problems arise in their operating models. Lastly, it's important to note that the professionals we have engaging with our clients and approving credits are highly experienced. In our Commercial division, every credit extension is evaluated based on specific criteria including credit quality, structure, and collateral. Our underwriting and credit teams consist of over 30-year veterans, many of whom come from major money-center banks. Despite being a relatively new company, we bring a wealth of experience to the table. We are also keenly aware of the risks associated with rising credit costs and their potential impact on operating performance.

That's very helpful. And then just a follow-up, Bruce, on the stock itself, I think you're very extensive to where the multiple is here. As we think about the CCAR process getting a little bit easier for regional banks to navigate, you could be one of the biggest beneficiaries there both can give a lot of capital, and I think you've been dinged because some of the legacy stuff that will change over time. But if your stock price does continue to sit at the bottom of the pack on a multiple lease, could you give a look for ways to get more aggressive on buybacks? It might not be necessarily the CCAR cycle, but are you mindful that you will have more flexibility and maybe put more toward buybacks versus bolt-on deals or balance sheet growth as we think about 2020, 2021, as kind of a backup plan if needed?

Well, look, obviously, we pay attention to the stock price but really the big focus is just keep running the company better than we think the stock will take care of itself. We have to be careful not to be market-timers here in terms of these programs. And you get your CCAR approval in quarterly windows and you can try to change that but it's a little cumbersome. So yes, I think when we go in and think about next year and the CCAR ask will take the stock price into account to some extent. But our view is that the flexibility that we've had, the ability to deploy it in some of these fee deals, it's a complex problem we're trying to solve. We're trying to get our returns up, but we're also trying to expand our capabilities and cement our relationships with our customers and address the kind of fee gap that we have. And so we'll continue, I think, to use good judgment on that like we have, like you've seen us in the past.

Maybe coming back to the net interest margin. Could you help us understand why you've got a stable outlook rather than some upside in 1Q? Given that we normally expect the benefit from the December rate rise to foremostly in the first quarter? And then looking ahead to 2019, the full year, I think the outlook kind of points to low to mid-single digits up from 2018. So similar to that 4Q '18 level, can you just confirm that?

I'm happy to address that. For the first quarter, we need to consider a few things. We experienced a December rate hike, and looking ahead, we anticipate a 17 basis point increase in LIBOR compared to the approximately 24 basis points in the fourth quarter. This will influence our commercial and industrial loans and loan yields. Additionally, the deposit cost lag after December typically peaks early in the year and gradually declines later in the year. Therefore, you will observe an ongoing increase in deposit costs in the first quarter that will be consistent across the industry. As the year progresses, deposit costs will decrease, while the strength from our fixed portfolio will continue to benefit us quarter after quarter. In early 2019, we might see more stability, but as the year advances, deposit costs will ease, and the benefit from our front book will be significant, with yields on front-book assets surpassing those on back-book assets by as much as 150 basis points. This dynamic, without intervention from management, is a net positive for us over the year. Furthermore, we are actively optimizing our balance sheet by transitioning lower-return assets to those with higher risk-adjusted returns and implementing initiatives on both the commercial and consumer deposit sides to enhance our deposit profile. We're looking forward to the potential contributions from these efforts in 2019.

One of your peers recently just announced that they purchased an online student lender, which obviously, can make him a little more aggressive with the higher end of the student lending space. Can you just talk about your very broadly your interest in acquiring tech companies specifically, to help either grow your loan portfolio or to even deepen your penetration that you have with your current clients?

Brad, why don't you just address where we sit relative to student loans and the threat we possibly see from that or not?

We have discussed this extensively and we have a strong interest in the student loan business. It attracts the right type of customers and we believe we are in a strong position. We have been competing with others for a while, so we do not believe this acquisition impacts our market position. We are very well positioned and it enhances our capabilities. As mentioned earlier, this acquisition brings in customers with high credit quality, contributing to our aim of shifting towards higher risk-adjusted returning assets.

Yes. And then the second part, Ken, is I think our fintech partnerships if you look at what we've done have really been powering new capabilities. So it's a kind of build-versus-buy decision that we take. And if, for example, SigFig has a great robo-advisory product, why should we build that? Let's just figure out which one is best on the market and then integrate it into our offerings. Same thing with our small business origination platform powered by Fundation. Why build that? You've got a great product capability. Figure out how to integrate it. So on and on and on, when you add up to 10 fintech partnerships, we've done a lot of that. And I think we've actually become quite good at surveilling the marketplace, having good prioritization of what's important and what can offer the best impact in terms of how we're running the bank and delivering for customers. And then we're effectively a very good general contractor, we know how to integrate these things reasonably, quickly, and cost-effectively.

Bruce, as you consider the leading banks and your goal to emulate them, what metrics do you see as indicators of top performance in this context?

Yes, that's a good question, Gerard. And I think it's not just financial so I think the kind of knee-jerk is well, he must be talking about a ROTCE or efficiency ratio or something like that. And I think to us, a top-performing bank is one that delivers well for all its stakeholders. And so consistently we've had an agenda of improvement as that what do we do across, what we call, the three C's, the customers, the colleagues, the communities. And I think we've seen tremendous progress there and there's more to go for us to be one of the most admired banks. We have to continue to drive our consumer J.D. Power score higher, our net promoter score higher. On commercial, we're pretty much there. We need more customers, we have kind of top-of-class customer satisfaction. On the colleague front, we want to be a great place to work and build a career. And so we have an organizational health index score that we're 2 points off the top quartile, so we've made a lot of progress from the middle of the third quartile, we're getting to the top quartile. If you're in the top quartile, you attract great people, you keep on and it helps drive stock outperformance so that's important to us. On the community front, we have taken our volunteer hours, almost tripled them from 50,000. When I walked in the door we had 135,000 this year, so really make an impact and spreading more as we make more money, we can also invest more money to make communities better places to live, work, and play in. Regulatory, we needed completely clean regulatory dance card, which we've achieved after a lot of hard work so that feels good as well. And then coming back to financial measures, yes, we've got to continue to drive our ROTCE higher. We haven't done that through deals as some of our peers have over time, we've done it effectively through organic growth. And so I think we're closing in on the pack and I think we can continue over the next 5 years to do what we've done to keep driving upwards within the peer group.

Great. Appreciate those insights. And then just is a quick follow-up, you've obviously done a few acquisitions, Franklin, et cetera. Is there an area that you're looking that you need to add to your product capabilities that maybe something that on the horizon you can acquire? And as part of that do you have any goals of where you'd like to see your fee revenues as a percentage of total revenues?

I'd say, Gerard, we're kind of constantly surveilling for opportunities and where we've seen a kind of desire for scale, things like the Capital Markets, M&A capabilities. There's more that we can do there. We're not done. Similarly in Wealth, I think we got a great franchise in Clarfeld. There's more that we can do there. Some of the other areas where we don't have capabilities, we can build those organically. So Don, I mean, you've added a par loan trading group, we're starting a little high-yield group. So there's things that we can do to expand our offerings, we're starting a commodities-trading service but we don't need to acquire things, we can just build those things. So I think you'll see us with a combination of building some things and looking for smart acquisitions. And to match earlier question, if you got to compare expending capital on these acquisitions with buying back your stock and it's a constant calibration that we're looking at. But so far, the deals that we've been able to find, we've been able to get them done at, I think, attractive ROICs and relatively short earn-back periods in terms of the impact on our tangible book value. Brad, you want to add to that?

Maybe just to add quickly to that, I think that over the medium term, we do aspire to grow fees faster than our net interest income line. And as that base has been growing over the past several years with the Fed hiking, just we've got to improve and innovate just to stay flat on the fee space. So I think we would see that improve a bit going forward, and we're in the high-20s right now, in terms of fees versus total revenues. And I think we'd like to see that get to 30 or higher.

Yes, I think like we've done is one step at a time, don't set the bar for where you want to be in five years. We're raising our ROTCE target modestly, and we think we can keep nudging it forward. The first step on the fees is to get back a three handle and get to 30 and then hopefully, over time, we can push it higher.

So the other thing that I was going to add, it's Don, we also view this, and you mentioned bright side of the house with partnerships very effectively. So in any expansion effort that were under way we look at organic build, we look at acquisition, we also look at partnership. And particularly, in our cash management businesses we've struck a number of partnerships, which have extended our product capabilities and will allow us to continue to grow that business.

And then the Commercial Real Estate, you might want to answer that.

Yes, and we have a very good partnership with Prudential on permanent real estate financing where they do permanent real estate against our construction books, and we go to market together. We have another very interesting partnership on the equity side for REIT Equity where we use an investment bank to co-market with us and do relending our REIT equity. So we've got quite a few of these, which allow us to broaden a service setting and capture more of the opportunity with the clients.

Yes, good.

Just back to credit report. Is there any part of the portfolio where you're seeing any indications of later-cycle behavior or any weakness you just want to flag? And then secondly, in terms of your credit outlook, the $400 million to $450 million provision guidance for 2019, what type of charge-off outlook does that imply in terms of a charge-off ratio for the year?

We feel very positive about the overall portfolio. In the Consumer segment, there are no visible trouble spots.

We really don't, Bruce. It's very solid and performing in line with...

No migrations in delinquency bucket. So you're feeling very good and Don, you obviously, there's no hotspot...

All the indicators are improving and our workout teams are relatively quiet.

Yes. When we look at the guidance for next year, we had an even higher target for this year and we exceeded that comfortably. There’s always an expectation that credit will return to normal. There’s also a belief that we will be increasing our allowance, so provisions should cover charge-offs. That did occur somewhat this year, but not to the extent we anticipated. This is mainly because the existing portfolio continues to improve and offset what we need to set aside for loan growth. That could happen again this year. I believe we will remain somewhat conservative and suggest numbers that imply some normalization and a significant increase in those figures. However, at this moment, we don’t see any major issues, and we might perform even better as the year progresses.

Got it, Bruce. That's helpful. And then secondly just on the loan growth front, wanted to get a little bit more granularity on how you're thinking about the components of commercial growth? When it comes to CRE, you had solid growth here in terms of high single digits on the linked quarter but even low double digits on a year-over-year basis. Can it grow at that high-single, low double-digit pace again, in '19? And then same question for pure C&I. Can it be in the high single-digit range as well?

When I respond to that, I think you'll notice lower growth levels in real estate, which is intentional. We're being more selective in our real estate underwriting because there is some speculation in that market. This is especially true in the multifamily space, where we adjusted our growth about two years ago and that portfolio is starting to mature. I would estimate our real estate growth in the low to mid-single digits. It's somewhat similar for C&I growth, which I have in the 5% to 6% range. You might see us exiting portfolios as we focus on BSO, meaning the actual gross growth could be lower as we trim the portfolio. However, we currently have very strong pipelines, and our origination pipelines are higher than at this time last year, indicating significant client interest in engaging and borrowing funds.

I think the fourth quarter was 8%, right?

Yes.

Year-over-year on commercial C&I. So that could still continue to run hard. I think what Don was saying there was that, that gives us the opportunity to review we have a quintile analysis, what our returns up and down the customer stack and if there's ones where we're not getting the right returns, we're not getting the cross-sell that we need, we can start to run some of those off to make room for new opportunities as they come on. So I don't think we grow C&I gross at 8, we grow it something less than that because we'll start to do that catharsis of moving some relationships.

And I think, back to the question that was asked before, I think what that does it allow us to move for fee lines also because we will be recycling for capital against higher opportunities on the fee side of the balance sheet. So look at loan growth and fee growth kind of in parallel.

Yes.

A little bit different take on capital. Talked a lot about share repurchase. But your dividend, you're guiding towards higher payout ratios, you had about 27% kind of ending this year. You're saying that next year is going to be 30%, 35% and then your medium term is 35% to 40%. One of the things that we did when we were managing a bank where we didn't think we're getting the valuation we wanted was the dividend is actually a better way to kind of show the strength of a growing franchise. If you're growing, the dividend really reflects the ability to be able to show the value of that income stream that you're creating. So I wanted to ask you in two cents, how do you bill? And like is that part of the progression that you're showing because that's going to be a very strong dividend increase over the next couple of years. And right now, you are at 4%-ish going to 5%. If you just look at the stock price, that start to move up before we think you will be by the end of next year. And then what about the sustainability of that dividend. What do you think about through the cycle being able to keep a 40% payout ratio?

Sure. I believe that's well mentioned. Looking at this year's results, we achieved 38% EPS growth and increased our dividend by 45% with the announcement made today. If we go back to October of last year, we've raised the dividend by 78% over the past 15 months. As our earnings have been growing strongly, we feel confident in raising our dividend and reaching a higher payout ratio. Previously, our payout ratios were somewhat restricted in banking due to the Fed's guidelines, which indicated a focus on the 30% mark. Now that our earnings have been growing rapidly, we have exceeded our budget, and while we've been slightly below that 30% target, with today's increase, we believe we can get back above 30% this year. If we continue the trend we've had over the last two years, we can expect a second increase later this year, as long as our earnings keep rising. Investors appreciate the dividend; those who own bank stocks are interested in the yield, and we are very mindful of that. John, would you like to add anything?

Yes, over time, as you approach your target capital ratio and reach a level of stability, you will consider solidifying the dividend based on your earnings, which is about one-third of your earnings in a given year. Additionally, you will look to deploy capital in organic ways, which will take up approximately another third or more of your earnings each year. The remaining portion will focus on strategic investments, whether that involves smaller acquisitions for fee income or returning capital to shareholders through buybacks. This approach will evolve over time, but the overall strategy will center around stabilization.

And then a totally different thought process, competitive advantage-wise, when you look at what we were talking about, if some of the growth that you're getting is from some very specific business lines but when we're in the area, community banks are saying is they're kind of thinking about the Boston or New England areas, they want to be more like Citizens Financial. You've been able to competitively advantage yourself in that region. So want you to talk about that. And then on the product side. How do you think you're going to create that same competitive advantage in cash management as you're investing in that? That's a product that has a lot of competition in it. So how do you position yourself in that particular product as well?

It's Don, I'll answer that. Our cash management business can be divided into several segments, including traditional treasury services, payments, credit cards, trade finance, and merchant services. Overall, this business is growing faster than the industry. We have been investing in it over the past few years, and it has shown substantial growth. We are well integrated with our core clients. We are currently focusing on enhancing our digital portal and expanding our capabilities to match or surpass the competition. We anticipate ongoing improvements from these investments, particularly starting in late 2019. Regarding competition with community banks, we are enhancing our product diversity to address clients' various needs. Our product offerings are nearly comprehensive, enabling us to address issues related to interest rates, currencies, commodities, raising capital for facilities, or regular working capital lending. I believe we can compete effectively not just with community banks but also with larger banks when it comes to solving problems for our clients' critical transactions. A significant factor in this is our recent acquisition, which has strengthened our position in assisting clients with crucial actions like mergers and acquisitions. I have no concerns about our competitiveness, especially in targeting mid-sized companies where we are very relevant.

And now to Marlin's earlier question on competitive advance. I think that certainly applies, and as we mentioned, we've made substantial investments and are focusing on our community initiatives, as this relates to the share of wallet discussion that we want to address. As we consider our engagement tools, both in cash management and retail, we have significant plans underway that I believe will become even more relevant, especially in relation to these community banks. So good times.

Just two quick questions. One on the fee income guidance for 2019, seems pretty strong. Did you give the impact of the CFA acquisition for 2019?

No, we hadn't. We didn't think that rose to the level of materiality as Franklin did.

Okay. And so drivers would primarily be what on the fee income side, in terms of 11% to 20%?

We discussed this earlier. On the commercial side, we are seeing a rebound in Capital Markets. Global Markets, including our FX and interest-rate business, has performed strongly, and we have launched new services in our cash management area. On the consumer side, we are also doing well, and I believe we will continue to perform strongly even without Clarfeld. Additionally, we have been investing in our card business to drive growth.

Yes, I think in terms of the drivers, I think this is a combination of strong underlying growth from all those segments, plus some continuing momentum from Franklin as we further integrate and leverage that business in 2019.