Citizens Financial Group, Inc. (CFG) Q3 2017 Earnings Report, Transcript and Summary

Good morning, everyone and welcome to the Citizens Financial Group Third Quarter of 2017 Earnings Conference Call. My name is Justin and I'll be your operator today. Currently, all participants are in a listen-only mode. And following the presentation, we'll conduct a brief question-and-answer session. As a reminder, today's event is being recorded. Now I'll turn the call over to Ellen Taylor, Head of Investor Relations. Ellen, you may begin.

Thanks so much, Justin and good morning everyone. We really appreciate you joining us this morning. We'll start off with our Chairman and CEO, Bruce Van Saun; and CFO, John Woods reviewing our third quarter results. And then we're going to open up the call for questions. We're really pleased to have with us today Brad Conner, our Head of Consumer Banking and Don McCree, our Head of Commercial Banking. I'd like to remind you all that in addition to our press release today, we posted a presentation and financial supplement on investor.citizensbank.com. And of course, our comments today will include forward-looking statements, which as you know are subject to risks and uncertainties. We provide information about the factors that may cause our results to differ materially from our expectations in our SEC filings, including the Form 8-K filed today. We also utilize non-GAAP financial measures and provide information and a reconciliation of those measures to GAAP in our SEC filings and earnings release material. And now with that, I'm going to hand it over to Bruce.

Thanks, Ellen. Good morning everyone and thanks for joining our call today. We're pleased to report another quarter of strong results, as our disciplined execution continues to drive strong momentum. The headline results show that we reached our key medium-term IPO target this quarter with a 10.1% ROTCE, a 59.4% efficiency ratio and a 1% ROA. This is notwithstanding a lower rate environment then was assumed back when the targets were set. While these results mark good and consistent progress, we have more work to do to run the bank ever better and become a top performing bank. I believe that the same formula that has taken us this far can continue to propel us to even better results. We're being very disciplined in where and how we play in our capital allocation. We have a mindset of continuous improvement that allows us to self-fund our growth investments, while delivering superior operating leverage. We've added some great talent and built out many excellent capabilities. And lastly and perhaps most importantly, we have focused on delivering a great customer experience in both the commercial and consumer segments. We've launched our TOP IV program and we continue to solidify and add initiatives. We pumped our target range by 5 million this quarter. We're putting a similar governance structure around our balance sheet optimization or "BSO" initiatives, which will be led by John Woods, our CFO. Turning to specific highlights of the quarter, we had excellent year-over-year revenue growth and operating leverage. Year-on-year, adjusted revenue was up 10% versus 3% adjusted expense growth, delivering 7% positive operating leverage. NII was up 12%, as loans grew by 5.4% and the net interest margin improved by 21 basis points, with about half of that due to self-improvement and half due to raise. Adjusted non-interest income was up 4% and that was really paced by strong growth in capital markets revenues. On a linked quarter basis, our underlying revenue growth was 2.5% against expense growth of 1% for 1.5% sequential operating leverage, which annualizes of course to 6%. NII was 3.5% sequentially - grew 3.5%. That was paced by 1.5% spot loan growth and an 8 basis point rise in the NIM to 3.05%. Our average loan growth was a little lower at 0.4%, which reflects somewhat the sluggish and stretched conditions in the C&I space that we saw throughout a good chunk of the quarter, but we're cautiously optimistic of a pick-up in Q4 continuing on into 2018. We continue to be highly focused on capital management. We returned $315 million to shareholders in Q1 or in Q3, I'm sorry. So overall, it was another strong quarter. We feel good about our positioning, the opportunities that we have in front of us and our ability to execute. So with that, let me turn it over to our CFO, John Woods to take you through the numbers in more detail. John?

Thanks, Bruce and good morning, everyone. Let's get started with our third quarter financials, which start on slide four. We generated net income of $348 million and diluted EPS of $0.68 per share. Our reported net income was up 9% compared with the second quarter, driven by higher net interest income and lower credit related costs. Year-over-year, net income was up 17% and EPS was up 21%. We also present our results on an adjusted or underlying basis in order to show a clear picture of the operating trends in our business. On this basis, net income for the third quarter was up 25%, EPS was up 31% and we delivered positive operating leverage of 7% year-over-year, reflecting revenue growth of 10% and expense growth of 3%. Net interest income of $1.1 billion increased 4% linked quarter, driven by loan growth, higher loan yields and benefit from pay accounts, partly offset by an expected increase in our funding cost. Our net interest margin increased eight basis points linked quarter and 21 basis points year-over-year. We will spend more time on the margin in a few minutes. On an underlying basis, non-interest income of $381 million was unchanged from second quarter and was up 4% year-over-year, while our efficiency ratio improved 95 basis points compared with the prior quarter and 390 basis points year-on-year excluding the notable item. We delivered more than 50 basis point sequential quarter increase in ROTCE this quarter to 10.1%, achieving the IPO-based new interim target of 10%. This result was up over 200 basis points from the prior year quarter before the impact of the notable items. Our efficiency ratio of 59.4% for the third quarter also exceeded our medium term IPO target of 60%. We are very pleased with these strong results, which reflect continued execution against our strategic initiative and our commitment to focus on continuous improvement to drive further revenue growth, while maintaining operating expense discipline. Although, we have attained our ROTCE target, we are confident that we can do even more to drive further improvement. We are constantly seeking to run the bank better and leverage the potential of our franchise. There continues to be upside from leveraging the investment for the past several years, optimizing the balance sheet and focusing on continuous improvement in how we serve customers and maximize efficiency. In a few minutes I will update you on the status of our TOP program, which will contribute further efficiencies and revenue opportunities, while funding investments to drive future growth. Taking a deeper look into NII and NIM on slide five and six, we continue to deliver attractive and disciplined balance sheet growth, which helped us drive a 4% linked quarter increase in NII for the quarter. We grew average loans and loans held for sale by 0.4% on a linked quarter basis and average retail loans were up 1.2%, offset by a small reduction in average commercial loans, largely reflecting the impact of the sale of $600 million of lower-return commercial loans in the second quarter. Excluding the impact of the sale, average commercial banking loans and loans held for sale were up 1%. On a period-end basis total loans and loans held for sale were up 1.5% linked quarter and up 5% year-over-year. Average loans and loans held for sale were up 5.4% year-over-year, I'll provide some additional detail on the growth shortly, including the impact of our balance sheet optimization effort. Net interest margin improved 8 basis points linked quarter and 21 basis points year-over-year. This reflects a nice improvement in loan yields given the benefit of our balance sheet optimization effort, which included an ongoing mix shift towards higher return category and the rise in short rate. The improvement in the margin, included a two basis point benefit from higher than expected commercial loan interest recovery. On a linked quarter basis consumer loan yields were up 11 basis points and commercial loan yields were up 25 basis points. An increase in funding cost partially offset the benefit of these higher loan yields. Deposit costs were higher by six basis points reflecting the rise in short rate and growth in the average commercial banking deposits. Total average deposits increased by 2% from the prior quarter while period end deposits were down slightly given an elevated level of commercial deposits at the end of the second quarter. Our average LDR came in at 97.6%, which was consistent with our outlook. Total funding costs were up seven basis points, which reflects the full quarter impact of our $1.5 billion senior debt issuance in May. Turning to fees on slide seven, on an underlying basis, non-interest income was stable linked quarter, as higher capital markets fees and service charges and fees were offset by lower mortgage fees and a reduction in foreign exchange and interest rate products. Capital Markets fees were a record for the quarter, and were up 47% year-over-year, showing continued momentum from the investments we've made in talent and broadening our capability, recording [ph] the strongest quarter given favorable capital markets, particularly in September. We also saw an increase in M&A fees following our second quarter acquisition of Western Reserve, most remaining fee categories were relatively stable linked quarter. Year-over-year on an adjusted basis, non-interest income was up approximately 4% This reflects strong contribution from the capital markets business given our expanding capabilities and higher card fees, which was our higher purchase volume, along with the benefit of revised contract terms for core processing fee, which commenced in the first quarter of this year. Mortgage banking fees were down as reductions in loans sale gains and spreads were partially offset by increase in servicing fees. Foreign exchange and interest rate products fees were also down, driven by a reduction in variable rate loan demand. Trust and investment sales were relatively stable as we continued to drive improvements in our mix of fee-based sale. Turning to expenses on slide 8, on an underlying basis, expenses were up $9 million, largely reflecting higher salaries and employees benefits tied to revenue growth initiatives and higher outside services cost which reflect cost tied to our strategic growth initiatives, along with an increase in other expense, which included $4 million in expense associated with legacy home equity operational cost. Year-on-year our adjusted expenses were up 3%. Salaries and benefits expense was higher, reflecting the impact of strategic hiring, merit increasing and higher revenue base incentive. We also saw an increase in outside services costs tied to our strategic growth initiative. We continue to remain highly disciplined on the expense front, as we identify opportunities to redeploy expense dollars part of lower value area in order to continue to self-fund our growth initiatives and enhanced capabilities to our customers. On 3Q expenses include approximately $15 million for our strategic growth initiative, including our efforts to improve our retail customer experience, expand our wealth management business, broadening our capital market capabilities and bolster our M&A advisory business. We funded these franchise investments with about $14 million in efficiency savings realized through our TOP programs and operational transformation initiatives. In short, we continue to seek opportunities to become more efficient which allows us to fund our growth initiatives and maintain strong operating leverage. With that let's move on and discuss the balance sheet. On slide 9, you can see we continue to grow our balance sheet and expand our NIM. Overall, average loans and loans held for sale were up 0.4% on a linked quarter basis and 5.4% year-over-year, driven by growth in education, mortgage and unsecured retail on the consumer side and broad strength across commercial. Commercial loan growth was muted by the impact of the sale of $596 million of lower return commercial loans and leases near the end of the second quarter, associated with our balance sheet optimization initiative. As I mentioned, NIM was up eight basis points in the quarter and 21 basis points year-over-year. These results reflect further expansion of our loan yields given our balance sheet optimization efforts which contributed about half of the year-over-year increase, continued discipline on pricing and the benefit of higher rates. We also benefited by about two basis points from higher than expected interest recoveries in commercial. Also we remain well positioned to capitalize on the rising rate environment with assets sensitivities relatively unchanged at 5.4%. On Page 10 and 11, we provide more detail on the loan growth in consumer and commercial. In consumer, we grew the portfolio 6% year-over-year, with continued expansion in the residential mortgages and education, which is largely tied to our refinance product, as well as continued strength in other unsecured retail loans, which continued to be driven by our product financing partnerships and our personal unsecured products. We are also seeing ongoing benefits from our focus on enhancing our portfolio mix by driving growth in higher return categories. As you know, we have been slowing growth in auto and that should continue overtime. As a result of these efforts, in addition to higher rate, we've expanded consumer portfolio yield by 11 basis points in the quarter and 38 basis points year-over-year. We also saw nice growth in commercial with average loan increasing 4% year-over-year, where we continue to execute well in commercial real estate, mid corporate and middle market, industry verticals, and franchise finance. This growth is muted somewhat of our efforts to reduce capital historically deployed against lower returning areas like select portions of the C&I book, where we aren't gaining in cross sell, and asset finance where we had originated big ticket leases given the overall RBS relationship. The overall goal is great returns and build strong relationships while still achieving good loan growth. The net results in Commercial reflected 25 basis point improvement in yields linked quarter and a 75 basis point increase year-over-year. On page 12, looking at the funding side, we saw a six basis points sequential quarter increase in our cost of deposits reflecting the impact of higher rates and growth and higher beta commercial deposits. We continue to find attractive balance sheet growth at accretive risk adjusted returns, which is driving NIM higher in spite of these rising deposit costs. Our funding costs were up seven basis points sequentially which reflects the full quarter impact of our $1.5 billion senior debt issuance in the second quarter. Year-over-year our cost of funds were up 19 basis points reflecting the impact of higher rates along with greater long-term funding. This compares with overall asset yield expansion of 39 basis points. We expect a slower rate of increase in fourth quarter deposit costs given the timing of rate hike and the impact of some of our deposit strategy. Next let's move to slide 13, and cover credit. Overall credit quality continues to be excellent reflecting the continued mix shift towards higher quality lower risks retail loans and a relatively overall clean position in the commercial book. The non-performing loan ratio decreased nine basis points versus the prior quarter to 85 basis points of loan this quarter while improving 20 basis points from the year ago quarter. The NPL coverage ratio improved to a 131% relative to 119% in the second quarter and 112% in the year ago quarter. The net charge-off rate decreased to 24 basis points from 28 basis points in the second quarter with continuing favorable credit trends and results. Our commercial net charge-offs netted down to zero this quarter, reflecting an increase in recovery while retail net charge-offs were $4 million higher than the second quarter in part due to higher seasonality in auto. Provision for credit losses of $72 million was $7 million above charge-offs which includes additional reserves for estimated hurricane losses. The reported provision was relatively stable compared to the second quarter and down $14 million versus a year ago reflecting the improvement in commercial due to recovery. Lastly as we continue to increase the mix of higher quality retail portfolios and our overall loan book, our allowance to total loans and leases ratio was relatively stable at 1.11%. On slide 14, you can see that we continue to maintain strong capital and liquidity position. We ended the quarter with a CET1 ratio of 11.1%. As part of our 2017 CCAR plan, this quarter we repurchased 6.5 million shares and returned over $350 million to shareholders including dividend. Our Board of Directors has declared a dividend of $0.18 a share today and we have authority through CCAR to increase the quarterly dividend again to $0.22 per share in early 2018 subject to regulatory [ph] approval. On slide 15, we showed a scorecard and how we are executing against our strategic initiatives. We are intensely focused on developing strong customer relationships and growing franchise in a profitable and sustainable way. In the consumer business, we are committed to becoming a trusted advisor to our customers through our clearer [ph] advice and product strategy. We continue to build out our mass affluent and affluent value propositions as these are key segments for us. We are also investing in several projects that will reengineer critical services we provide to customers. This should result in the improved customer experience and greater efficiency. We continue to drive attractive loan growth across the network, which has been our education refinancing loan product and total partnership length and stronger credit which had attractive risk adjusted returns, as we optimize the balance sheet we have continue to reduce the auto portfolio in order to enhance return. And while we continue to build scale and add capabilities highlighted by the launch of SpeciFi our new digital investment advisory platform, we also saw continued progress migrating sales mix towards fee based product which represented 41% of investment sales in the third quarter in 2017 compared to just 30% a year ago. We have increased our efforts to reposition and improve the returns in our mortgage business in the current environment. We trimmed our loan officer headcount by about 10% in the quarter in order to drive productivity and increase our focus on conforming loan mix. In addition, we are investing in a direct to consumer origination platform which we believe will provide a lower cost challenge to originate performing mortgages. In Commercial, our expanded capabilities helped deliver another very strong quarter in capital markets as we continue to leverage the investments we've made including our enhanced bond underwriting platform and our recent acquisition of Western Reserve. Treasury solutions continues its steady progress with fee income growth of 7% year-over-year due to strong momentum in our commercial card program as purchased volume was up 35% year-over-year, driving a 31% increase in fees. Our initiatives to deepen customer relationships are helping to drive continued balance sheet and customer growth with 5% average loan growth year-over-year reflecting strength in middle market, commercial real estate, corporate finance, franchise finance and mid-corporate. We're also starting to see the benefits of our geographic expansion initiatives with strong balance sheet and fee growth in those markets. The TOP program had successfully delivered efficiencies that allowed us to self-fund investments to improve our platform and product offering. We have largely completed the actions needed for the TOP III program which launched in May 2016 and is expected to deliver run rate benefits of approximately $110 million by the end of this year. Our TOP IV program is a further example of our commitment to continuous improvement and delivering value to our shareholders. As we work through our combination of initiatives to enhance revenues and drive efficiencies we are raising our target for the program by $5 million to a run rate pretax benefit of $95 million to a $110 million by late 2018. On slide 16 you can see the steady and impressive progress we're making against financial target. As previously noted this quarter we hit our 10% post-IPO medium term ROTCE target. Since third quarter '13 our ROTCE has improved from 4.3% to 10.1%. Our efficiency ratio has improved by nine percentage point over that same timeframe from 68% to 59.4%, exceeding our medium term IPO target of 60%. And EPS continued on a very strong trajectory as well, up 160% in four years from $0.68 from $0.26 with a CAGR of 27%. This rate of growth and improvement continues to outperform peers over the period as we have made efforts [ph] in terms of key performance measures. That said we still have opportunities for further improvement and we'll work hard to deliver that. Now let's turn to our third quarter outlook on slide 17. We expect to produce linked quarter average loan growth of around 1% to 1.25%. We also expect net interest margin to remain broadly stable linked quarter. We are expecting non-interest income to be broadly stable given the record level of capital markets fees in Q3. We also expect to realize a modest TDR transaction gain in 4Q, which will be offset by costs associated with our strategic growth initiatives. We will treat those as notable items so you will be able to clearly see the operating trends in our business. We expect expenses to be broadly stable in the fourth quarter, perhaps up a tad given seasonality. Additionally we expect provision expense to improve to the range of $80 million to $90 million, reflecting loan growth and a modest increase in commercial net charge-offs given the higher level of recoveries in the third quarter. We expect the tax rate to tick up temporarily to around 34% for the fourth quarter as a result of an $8 million impact on the tax line tied to the launch of our historic tax credit investment program this year. The full year 2017 tax rate is expected to be about 31% on a reported basis and 32.25% on an underlying basis, excluding our 1Q '17 settlement. We expect to manage our Step I ratio to around 10.9% with an expected average diluted share count of approximately $490 million to $495 million. And finally we expect the average LDR to be in the 97% to 98% range. With that let me turn it back to Bruce.

Okay thanks John. And with that operator why don't we open up for some Q&A.

Thank you, Mr. Van Saun. We're now ready for the Q&A portion of the call. [Operator Instructions] Your first question comes from the line of Ken Usdin of Jefferies. Your line is open.

Hey, thanks. Good morning guys. I was wondering John if you can talk a little bit more about that balance sheet optimization side, and specifically how do you expect that to work through the asset yield side of the equation? What are the areas you'll continue to kind of move out of low return and how much can that help the overall asset yield going forward ex-rates?

Yeah, thanks, Ken, good question. We're thinking that the key areas that we'll focus on would be in the consumer side, it could be even - I mentioned it before that auto is a low return business. We like our auto business. But we're moderating the portion of the balance sheet that auto will take up going forward. So you could see loan yields rising as a result of that. On the commercial side, the areas that we're looking at, as you may have heard in my remarks include on an ongoing basis taking a look at the back book in C&I, which is a typical business as usual, kind of behavior. But we think that can add benefits to loan yields over time. As well as in asset finance. As we mentioned we have some legacy assets that were put on during [indiscernible] days in the larger ticket area. We've been moderating our exposure there. We'll also drive loan yields higher. So I think we've got a lot of benefit going forward in balance sheet optimization. So we're optimistic that, that will provide lift ex-rates in the future.

And Ken, it's Bruce, I'll just add to that. I think what we're really seeking to do is put a little more program discipline. I think we've been doing a good job of balance sheet optimization all along. But we're going to look for opportunities to shift the mix in consumer in particular and formalize that, and have targets in place. We'll look for pricing discipline across all portfolios John mentioned auto. But I think there is opportunities in elsewhere, in consumer and then in commercial in particular as we look at rollovers. So we will have a program that allocates out responsibilities to specific individuals with targets that we monitor much the way we run the TOP program.

Great, thanks for that color Bruce. And just a second question, then how does that translate into earnings asset growth. I would presume that this assumes that out even as you deemphasize some and grow others that you'll still planned to net grow loans. And can you help us just triangulate how that translates between loan growth and turning into earning asset growth. This was the first quarter in a while where we saw flattening out on the earning asset growth side. Thanks guys.

Yeah. And there again I think the goal is to continue to achieve good levels, robust levels of earning asset growth going forward, while we're making those remixing decisions. But I think we've done that pretty well all along. I'd say the things that hit the numbers this quarter really was the aftermath of that late Q2 loan sale on commercial and then some. I'd say the stretched conditions that we saw in commercial we're not really going to push on our rope here. If it's not there we'll be disciplined, but I think we saw in September things starting to pick up a bit. And I think the sentiment in Washington if we start to see the pro-growth agenda take place that can also create I think more loan demand which will ease some of the pressures that we're seeing on the commercial side. I might flip it over to Don for some color there.

Yeah I think that's exactly right. The other thing I'd mention is we did have a reasonably strong quarter in our bond businesses, which were reflected in a little bit of a reduction of our outstandings from utilization standpoint, particularly on the corporate businesses. So we picked up a little bit on the fee line while we saw a little bit of moderation in the loan growth. Our pipelines look pretty strong right now and I would just echo what Bruce said around terms and conditions. It's very aggressive out there with everyone looking for loan growth. So if transactions are getting too stretched from a terms and conditions from a pricing standpoint, we'll probably stand back and let that go away. So that will be a moderating factor, but as we look deeper into the fourth quarter and into next year and begin to get some certainty around some policy coming out of Washington we think it could be a quite a good backdrop for continued expansion of the business. And then the last thing I'd say as we are seeing a really good client growth in our expansion markets. So while terms and conditions are tough, we're adding clients and that should result in incremental demand as we go forward.

And I'd just add to that, I'll flip it to Brad too for some color. But the other thing I'd point out Ken is that we’re very consistent on our consumer side loan growth. So we've been kind of in a 5.5%, 6% annualized growth rate every quarter which we saw again this past quarter. I think some of the reason we've been able to achieve that is we have unique spaces that we're playing, such as the education refinance market, such as personnel unsecured with our corporate partners. And so we expect to continue to see opportunities to build on that. And so that can inure us from any little dips that we see in the overall consumer loan demands. So Brad maybe --.

Yeah. Bruce I think you articulated it well. We've got a unique space in student and unsecured which is providing the runway for both of those to continue to grow. We've had good growth in mortgage lending and we believe that will continue. And really what we're talking about in auto really shouldn't change the trend line because we've already been pulling back in auto. In fact you saw that.

Yeah.

Begin to reduce in and we've got out of this relationship a couple of quarter or last quarter or so. I think there is plenty of reason to believe that the trends that we've seen up until now can continue.

Yeah. Got it. Thanks very much.

Hey, Ken.

The next question comes from the line of John Pancari of Evercore. Your line is open.

Good morning.

Hi.

Also on the balance sheet side, I just wanted to talk a little bit about what you're seeing in terms of deposit competition and is there pressure to implement pricing programs to bring in deposits? And also what do you see right now as to what your deposit beta is trending and what're you thinking could move?

Yeah, why don’t I start and flip it to John. But you know I think the consumer side continues to be well behaved. And so I think we're continuing to see discipline hold throughout the market and the higher you get in the cycle you start to see the betas rise. But right now they are still quite low. On a commercial side obviously there is sophisticated companies there, as you particularly get up into the bigger size companies, they have treasurers and they're looking for - to participate as rates go up. They see the cost of their loans going up. So they want that cost on the funds that they're leaving with us to reflect the rate rise. And so I think we've done a good job of continuing to grow there and rotate out some of the higher cost segments like financial institutions and government and try to get more organic growth coming from corporates. And then particular areas that we haven't really fished for deposits in like commercial real estate, we are launching some new products like escrow deposit. So I think overall, we're really pleased that we're tracking to our own models in terms of how things are going. And the last thing I'll say is that we're also - even though we're paying up a little for these deposits, what we're doing with the funds in terms of the loan growth that we're funding is very attractive. So the areas that Brad just talked at Refi loans, the personal unsecured loans have very good yields. And so it continues to benefit us, these transactions at the margin, if you look at match funding of what's growing and the asset side what's growing on the deposit side, those were very accretive and they are accretive to our NIM and they are accretive to our ROTCE So with that why don't I pass it over to you John.

Okay. Yes, just getting into the deposit beta part of it, so you asked about where we are on there? So on a cumulative basis through 3Q total deposit beta will be 17% and in quarter sequentially up 36% [ph] for the third quarter. We would see that coming down a bit in the fourth quarter, in part due to the fact the Fed going to take a quarter off and give here in the third quarter. And also just give us some breathing room to allow the deposit initiative to really start to kick in. So on the consumer side, the investment that we're making in beta and analytics and really we're finding our promotional approach. And on the commercial side the investments that we're making in product offerings and targeting with respect to the segments that are more deposit rich. So that kind of optimization going on the deposit side, along with the where the macro coming out we will see the betas, in core betas come down there in 4Q.

Okay, John, thank you. That's helpful. Then separately on the credit side, I know you saw your order losses increase on a linked-quarter basis, and I know you pointed to seasonality there as well, but they are also up 14 basis points year-over-year. So can you just talk about what you're seeing there in terms of order losses and your outlook as we go forward? Thanks.

Let me start perhaps and flip to you but, I would say on a linked-quarter there is partly seasonality. The other thing that we're seeing is a little bit of kick up related to our out of state, out of footprint state expansion initiatives that we commenced about two years ago. And I think there might have been a little adverse selection there in a couple of states. And so those linkages are having slightly higher loss rates in net earning [ph] is quite true. It's not anything that is significant. We have since when we decided that we're going to start to run down the size of the auto portfolio we've now exited in those states. And so it's limited to a fairly narrow period vintage wise but that's really I think the main thing that you're seeing there. Brad you want to add to that?

You hit it. 2Q is seasonally low, that is the typical seasonally low period. So that explains the quarterly increase and to the point we've got very isolated, it was related to auto footprint 2016 vintages. We stopped those vintages right away. And the other thing I would just point out was we said for quite some time we've began to expand our credit from super prime to sort of mainstream prime. So we always expected a little bit of an increase and very much in line with what we expected and we have given some guidance on consumer losses a quarter plus ago.

Yeah, so not something that we're worried about. So tracking to what we expected.

Tracking to what we expected exactly.

Okay and that auto footprint stuff, that should be - that adds to the [ph] year-over-year pressure?

I'm sorry you broke up there.

The year-over-year increase in auto losses that's mainly coming from the auto footprint stuff?

Yeah, I think it's the two, it's the auto footprint plus the starting - when we've started to mixing more prime in with the super prime correct.

Got it, and the size of that auto footprint?

It's relatively small, and it's quite small on an overall basis. The vintage we're seeing the stress in we stopped originating in that, that's [Multiple Speakers] we spotted. So it'll be an immaterial piece of the portfolio.

Got it, okay, thank you.

Next question comes from Brian Klock of Keefe Bruyette & Woods. Your line is open.

Hey good morning gentlemen. So congratulations first on hitting the 10% return on common equity target. And then I'll start with the good momentum you guys have had in the commercial bank and with the sort of retooling there. A lot of your peers haven't posted positive C&I growth. So if you can talk about what you're seeing there, what's helping contribute to your better than peer growth in the commercial book?

Yeah, let me start and flip to Don, but I think there's a couple of things one is that we continued to add great coverage bankers as we've expanded geographically, brought in some really excellent bankers from some of our regional peers, to head up those efforts. And so as they build out their teams it's natural that we're going to gain market share, and as they bring some of their relationships over to citizens. We added a new Head of Healthcare industry vertical as well. So really part of it is just we're playing offence, we're trying to expand the overall customer base and that's allowing us to grow. The other thing I'd say is that we've just focused on pockets where we do expect that there should be relatively more growth. So some of the mid-corporate bigger sized companies historically we were a little bit under scale there. We were focused more on the middle market. I think if you go back or maybe the four years I've been here, we've taken the middle market customer count from say 2000 to close to 2500 but the mid-corporate companies with revenues from $500 to $2.5 billion we've taken that from 450 to 750, and those tend to be bigger credits overall. So we've seen some nice growth there. So that's really I think reflective of the growth investments that we're making and then the focus that we have on particular industries and companies. Don?

I think that's right, the discipline around client planning and market planning is at a totally different level than it was a few years ago so that is presenting a little bit of a tailwind to us. And I think in addition to the bankers that we've hired, we vastly improved our product capability. So the relevance that we're going to market with across the trading rooms, across the capital markets, across M&A now it's resonating with the client. We're still a relatively mid-sized bank, but we have world class players in our sweet spot which is the middle market in the low end of the larger companies. We've just got great bankers out in front of these clients and it's terrific traction. So we're very pleased with the progress we've made and as Bruce said, we've added probably 40 bankers in our expansion markets over the last quarter and half and they're from really strong local banks SunTrust and U.S. bank and JP Morgan and in the various markets and they bring clients with them and we're already winning business because of their relationships so it's very encouraging.

And thanks for the color and just a follow-up on the consumer side, you mentioned earlier Bruce, the good growth from the investments you've made there and obviously the education book is growing pretty well, very strong, if maybe you can, you or Brad can kind of give us the break out in that education book of how much is come from your core refinance product the in-school and your relationship with SoFi.

I'll steer that directly to Brad.

Yeah. So there was couple of events of that but if you - let me answer from the standpoint of originations in the third quarter. So the third quarter originations about 10% of our student originations came from purchasing SoFi loans, about 60% of our work came from the - 55% are so came from our own organic originations and then the remainder from are Ed Refi, yeah, I'm in the remainder from the in-school product. So it's about 90% of our block was - in the third quarter was organic originations.

Perfect, thanks for your time guys.

Sure.

Your next question comes from the line of Ken Zerbe with Morgan Stanley. Your line is now open.

Great, thanks. Good morning.

Hi.

In terms of - let's assume that the market - or we don't get the very hikes that the market expects, right, if we look at just simply the remixing of your assets into a higher yielding asset classes, but also so that I'm assuming a natural upward pricing and deposit, betas around deposit cost, can you get NIM expansion just from those two pieces without higher rates?

Yeah. I think enough for two Ken, but I think if you look at the year-on-year growth in the NIM of 21 basis points, about half of that was self-help, and then the other half was really due to rates, if rates didn't move higher I think you would have the less pressure on your deposit cost for sure. So I'm not sure you'd be getting the squeeze there, it would be the - what we saw when we were lower for longer, there is an opportunity cost of the asset sensitive position in no rate hikes, but there is general stability in that environment. So it puts the onus back on us to keep remixing and being disciplined on pricing and some other things we've talked about earlier in the call around balance sheet optimization which I think can still help us get some NIM less, so John you want to add to that?

Yeah. Well, said, I think the one way to think about is that we're still on a business ex perspective about, call it 15 basis points below the median of the normally situated [ph] peers. And so without rates moving, we feel like we're in the - we've made a lot of progress on balance sheet optimization. We feel like we can make a big dent in quality, just like we're doing on the profitability side, top of the house in ROTCE. We're going to be closing the gap on the NIM side as well. And that doesn't depend on rate, given what you heard Bruce, in terms of the mix shift alone drove about half of our benefits year-over-year.

All right. Great. And just staying with the deposit side - sorry the funding side, I saw you used some cash to pay down a bit of FHLB this quarter. Are you done with most of sort of the restructuring of the deposit side, such that we are at a good point between wholesale borrowings and core deposits, or is there more to go?

Yeah. I think we're [indiscernible], if you look at - I think we're in the neighborhood of 14 million [ph] or so of borrowings. That should be about stable going forward. We think about that in terms of generally wholesale borrowings funding portfolio. So we look at the whole balance sheet. We're in kind of at right spot. And so what we expect to see big changes in that going forward.

Great, thank you.

And your next question comes from the line of Peter Winter, Wedbush Securities. Your line is now open.

Good morning.

Hi.

On the fee income side, the outlook for the fourth quarter is kind of stable. I'm just looking out in 2018, where you see some of the biggest opportunities on the fee income side? And then secondly any thought about fee income acquisitions to enhance some of that growth?

I'll start as usual and then maybe flip to John for some additional color. But I think the positioning we have on the commercial side is quite strong across everything we're doing. So our capital markets capability, the purchase of M&A capabilities with Western Reserve and integration and ability to start creating more leverage and more flow opportunities for them. And I think we have opportunities to just to continue to expand capabilities pushing to things like securitization and some other initiatives that we have. So everything of the capital markets platform provided that the market conditions stay favorable, I think we can continue to see growth there. I do think on the global markets which is our FX and interest rate risk management platform that we are still scratching the surface. We used to be on RBS' platforms, we've migrated to our own platforms. We I think have a much broader capability in terms of product. And then also we've up tiered the quality of our team. So we have I think more intellectual capital and ability to show good ideas to our customer base. So I'd see nice upside there. And then on our cash management business, we've also upscaled our capabilities. We're working through a replatforming of the business that will, I think, put us right up there with the top sized banks in terms of capabilities. And that will be implemented late in 2018. So I see some potential some momentum there. So I'm feeling good about what we've accomplished so far in commercial and I think we're positioned for further growth. On the consumer side, it's been a little tougher slotting. One of the things we've invested heavily is our wealth management capability. We see really lots of potential there, untapped opportunity. And I think we're have the business positioned very well to start to gain further traction to have that show up in the numbers. I think at this point we're kind of expanding the relationships that we have inside the branch business, but we're moving more towards the mix of managed money as opposed to what we did historically, which was more transaction based sales and annuity type products. I think that's great for customers and it's great for us in the long-term, but it creates a near term revenue headwind which the lines haven't really crossed yet. So we've been building up our managed money book. That's creating I think more of an annuity type revenue stream going forward, but that's resulted in the business being somewhat flattish over the past six quarters or so. I expect we'll start to see that breakout and we should see growth there in 2018. And then the mortgage business has been - we've done some very good things and putting a good foundation in place. Our servicing and fulfillment capabilities are amongst the best rated by JD Powers consistently and that wasn't the case the couple of years ago. But we still have to, I think hone the model to get more conforming loan officers that are better integrated into the branches and build some additional capabilities direct to consumer potentially enter into the correspondent business. So there is more work to do there, but ultimately there will be revenue upside there as we get that right. So that's kind of a long winded answer. I don't know if there any additional color John that you want to add to that?

I think you hit it. We're making investments across these four or five businesses, and I think that capital markets we have seen some breakout. But I don't think we call any of these businesses fully insured [ph], and so I think that's the forward-looking view on [indiscernible] going forward.

Anything from Don or --?

No, I think you've covered it.

The only thing I would add is that I think on the mortgage side in terms of the opportunity to continue to grow speed, bring more scale, we talked about possibly getting into the corresponding business, maybe acquisition and then getting more scale and a very good servicing operation that we have is a real opportunity for us.

Yeah, great. And then the last part you said potentially more acquisitions, I think yeah. I think we will look to do smart bolt on acquisitions potentially in the areas that we just talked about, if it can get us farther down the track faster I like to say. So like with the M&A boutique, Western Reserve that we did in 2017 they took us from roughly six M&A bankers to 36 M&A bankers which given the size client base we have is where we need to be. We potentially still can scale up I think and serve our customers well. But if there is things we find in wealth or capital markets or the payments space that make sense to us, we're going to start having the periscope out and start to look at things. But again I think there will be very digestible from a size standpoint. They won't knock us off our game in terms of capital return. And so I think they will just be things that we feel make sense. They're down the fairway, they fit and they can help address the need to get up that fee percentage and do more for our customer base.

Great. Thanks a lot, great color. Thank you.

Sure.

And your next question comes from the line of Vivek Juneja of JPMorgan. Your line is now open.

Thanks. Hi Bruce, hi John. Question on your consumer loans, loans to - for financing iPhones and Vivint [ph] et cetera. Can you give some color on how that's doing, it seems like we could need to see growth there which - off those products, are you seeing more of it? And also some color on the credit performance you've seen since you've started this several quarters ago now.

Yeah, I'll take that. And we're very pleased with the programs. Continue to go very well in both the Apple program and Vivint program are growing for us. They've been very good partners. We do have other similar type of retailers and merchants coming to us asking us to work with them on building programs for them. So we certainly think that there is upside. The credit performance has been very good and in line with our expectations and I'll just throw out a reminder that all the programs that we've entered into up until now have a degree of risk sharing. So that even makes the credit performance more stable on those programs. So all in all, we're very bullish on that as a business opportunity.

Okay. Thank you.

Your next question comes from the line of Geoffrey Elliott of Autonomous Research. Your line is now open.

Hello, good morning. Thank you for taking the question. First, just a little clarification, on the NIM outlook the broadly stable, is the base for that the 3.05 or is the base 3.05 excluding the clash loan recovery, so 3.03?

That's the 3.05.

Great, thanks. And then I remember back at the time of the IPO you had the midterm 10% ROTCE target. And then you've also had a longer term target and I think you had some charts pointing to something more in the 12% range for that. I guess the question will be you've got to the 10% this quarter, how long do you think long-term is now?

Well, I think the 10% we've build those is our medium term IPO base targets. And I think what we have said all along is let us achieve those targets before we raise the bar. It feels great to work hard and execute well and hit those targets. And think we will as we work on our budget for next year and freshen our strategic plan, you could expect us at some point next year to give you some additional targets that would be higher than where we are today. So I said in my opening remarks that I do think, what's gotten us this far, what's taken us from 4 to 10 is still pretty much the crux of how we want to operate the business. We want to be disciplined on expenses to try to find efficiencies. So we confirmed our growth and investments. We have a very strong capital position, so we can continue to grow the balance sheet and bring new customers to the bank. We're investing in the fee businesses and we should start to see increasing traction through deeper customer relationships. So everything that's taken us from 4 to 10 should be able to continue to propel us higher as long as we stay really disciplined and execute really well. So stay tuned and we'll I think have a comparable set of targets that we would move higher and that will be sometime in 2018 we'll reveal that.

Great. Thanks very much.

Okay.

The next question comes from the line of Matt O'Connor of Deutsche Bank. Your line is now open.

Good morning. Most of my questions have been answered. But just on the tax rate, what should we think about for 2018? Obviously some noise in the fourth quarter that you've alluded to, but what's a good run-rate? I know there been some efforts at the top to lower that in general?

I would say I'll start and John, if you want to add color, but if you look at the underlying rate for the year take out the noise of some recoveries in Q1 and historical credit matter in Q4, we're about 32 in a quarter, there is a constant tension between the growth in net income that we have and then the planning that we can actually do to knock the rate down from what statutory rates are. So we will continue to work through that, and we'll give you guidance on that in January when we have our year-end call, and give our outlook for 2018. But those are really the dynamics. We have income growth which comes through at a higher fully effective rate, and then we have to figure out plans like low income housing and other federal credit programs, that we invest and we continue to lock the rating around 32 which is where it is now. Obviously the wild card in all this is the corporate tax reform and we will be a big beneficiary of that staying at 32% rate. Clearly would increase our after tax cash flow and our EPS and ROTCE and all those measures by a significant amount. So certainly I think there is broader benefits to the economy from getting a tax reform and tax cut package in place, but there is specific benefits to regional banks and to us in particular even our high tax rate. And that also may knock out some of the program. So right now I think the scuttlebutt is that low income housing would be continued, but many of the other programs around energy, around historical tax credits, the broad range will be up and they will be grandfathered but you won't be able to continue with some of those programs but there will really be less need to do those kind of investments if the rate is lower in the first place. So, John, anything to add on that?

Yes, just to add that so our tax rate being in the neighborhood of 32%, the attention that we have indicated [ph]. I think part of reason for that is that we are under penetrated in tax advantaged investments and the text credit opportunities that many of our peers have availed themselves over many, many years. So we got started as a little bit latter and we are catching up and we will catch up overtime and continue to invest in those programs. So but you'll see that that offset our earnings growth being offset by a ramp on catching up to the pack in the tax exempt area.

Okay. It's helpful. Thank you.

Due to time constrains, we will turn the call back over to Mr. Van Saun at this time.

Okay. Actually we could go, if there is a few more people in the queue, we can take up two or three more, Justin.

Sure, we do have some questions here in queue for you. Next we'll go to line of Marty Mosby of Vining Sparks. Your line is open.

Thank you, well saved by the bell there. I want to ask you about when you look at the increase in your loan yields, 75 basis points increase or 75 basis points increase in the fed fund rate, so again almost a 100% beta on your asset side. Now some of that's related to just being asset sensitive and some that's related to the balance sheet optimization. But there is a strategic decision ahead of the company which is, when do you begin to think about neutralizing some of your asset sensitivity. So just wanted to get a feel for how you're thinking about and tackling that strategic decision that's in front of you?

All right, so what we've seen overtime is that we managed that, in let's just talk about the gradual rate rise scenario up 200. We've been in that 6% to 7% benefit position from that scenario. That's overtime come down to around 5.5% and it happens naturally just as rates start to rise - we start to roll down. I still think that, that positioning to stay asset sensitive, as we are in the early part of the rate list cycle is a sensible place to be, because we have a coil spring that releases, and every time the fed continues to move, and rates continue to go higher. And I don't think that cycle is through yet. So we'll stay asset sensitive, we'll glide down and that's how we are planning to manage it. I think it's too early to go upon a big hedge and try to capture the additional income because I think you give up a fair amount of your upside. John, anything you want to add?

No I think you hit it well, nothing I would add.

And then you mentioned your loan to deposit ratio is one of the things you're really guiding towards, is that because you feel like that is a constraint in liquidity or do you look at more the liquidity coverage ratio as the way you're managing liquidity on a tactical basis?

Yeah I think you hit it there. I mean we started to build liquidity coverage ratio as basically how we look at those, and I think that's a much more sensitive measurement of what our liquid asset position is versus what deposit outflows could be in [indiscernible]. So it's a much more reliable measure and we have a strong LCR ratio. Year over year it's more of an output of that, but nevertheless it is a helpful measure to report and easy to calculate, it's right off the balance sheet. So we look at both, but the primary measure really is the LCR.

So no reason to think there's any constraints from a liquidity standpoint in the near term?

Well, no. We manage all of our resources as if there are constrained, right I mean so capital liquidity is better up, and we balance our liquidity, our sources against our opportunities on the asset side. And so we're seeing nice flows on the deposit side. We have 2% growth in deposits this quarter which is high end of peers. So we're feeling pretty good about our ability to fund our growth going forward.

Yeah and the LCR is well above the minimums. So feeling quite good about where the liquidity and funding position sits today.

Perfect thanks.

And your next question comes from the line of Kevin Barker of Piper Jaffray. Your line is now open.

Good morning. Could you talk about the credit performance that you're seeing within the student loan portfolio from the 10% originations from SOFI and the 55% organic and then also the in school product that you also mentioned?

Yeah they're all performing extremely well. We monitor it very, very closely, as you would fully expect, we look at each and every little vintage, look at the emergence of the loss curves for each individual vintage, and each and every vintage of those portfolios is performing right in line with the expectation that we have, and in some cases better. So we don't see any stress in those portfolios. Keep in mind that we play very much in the super prime space as it relates to those products. So we have average FICOs in the 780 range or above for all of our originations. So these are very high credit quality loans and we're improving the credit quality with our cash flow of the borrowers with the refi products. So they're performing extremely well.

Okay and then a quick follow up on some of the deposit conversation, are you seeing deposit betas accelerate in certain markets more than others, specifically in the Northeast versus some of your Midwest branches?

Deposit betas, is there is geographical disparity in that?

There is a little bit I mean we certainly see some competition, some difference in competition and in terms of what are the lean rates for money markets and CD, there is a geographic mix to that. But beyond that no measurable difference then in betas by geography.

Yeah so nothing large scale today, as Brad mentioned. Maybe a bit more traffic in the CD area where we're seeing it, seeing some great [indiscernible], but not as much in money market. So our cost of funds impact is limited.

Thank you.

Okay Justin, we probably have time for one more.

Certainly, our last question comes from the line of David Eads of UBS. Your line is now open.

Hello, thanks for taking the question. Going back to the balance sheet, there was a - about a little over half a billion dollar increase in the other loans held for sale category. Just curious is that agency mortgages or is that some other sort of loan portfolio that's being positioned for sale? And I guess kind of on the mortgage side you're talking about repositioning that business. Should we expect the amount to be held on a balance sheet, the pace of growth on the balance sheet to slow, or is that really, okay you're going to try to keep [ph] now that you see business growing about the same pace and just accelerating the pace?

I'll try to jump in on that and others can add in. So in the other - what's held for sale is mortgage stuff but it's also loans that were pending syndication. So you'll see both of that driving the held for sale category and so they are both drivers, and we had flow in both of those areas that would increase to the health of those numbers at the end of September in particular the syndication volume that is yet to be pulled down. On the mortgage fronts, yeah, I mean I think we're looking to remix our off balance sheet leverage, if you will, and some non-conforming piece, but the non-conforming is still a good product for us. We're seeing good risk adjusted returns there, they drive customers in to the bank. Those customers are candidates for deposit products and maybe are actually existing customers of the bank that we're serving and they are also candidates for our other offerings. We are looking to drive both of those and the off balance sheet conforming piece won't come at the sacrifice of non-confirming piece.

Okay any color Brad or --?

No, I think that John said it exactly right. We are looking to really just acceleration of the non-conforming piece.

Right, thank you.

Okay. Well, why don't I just wrap up the call here by thanking you once again for dialing in today. We truly appreciate your interest. It's really gratifying to hit our milestones this quarter. We're going to continue to stay focused on the work in front of us, yet to come to build a great bank and to do even better. So thank you and have a great day.

That now concludes today's conference call. Thank you for your participation. You may now disconnect.